Chapter 14 Managing the Information Technology Resource 1
Chapter 14
Assessing the Value of IT
True-False Questions
1.
The use of the ROI method has often led to its manipulation by managers attempting to show
enhanced short-term results.
2.
Residual income is calculated as the difference between reported operating income and the
financial opportunity cost of the investment base.
3.
EVA is an extension of the residual income technique.
4.
The EVA method attempts to remove distortions to the investment decision that are created
by GAAP.
5.
A difference between standard NPV and modified NPV is that the standard NPV includes the
interest earned during the deferral period.
6.
A strongpoint of discounted cash flow analyses, such as ROI and residual income, is that
they are good for valuing strategic investment proposals having dynamic, strategic
characteristics.
7.
A limitation of real options is that there is no option to defer an investment until some future
time.
8.
A limitation of decision tree analysis is that it does not require analysis of options available
to managers to amend their strategic plans as they unfold over time.
2
9.
A strength of ROI is that it looks at both the tangible and intangible value of IT investments.
10.
The “tomato garden” is a framework that depicts two elements of value provided by a real
option, as represented by a project’s cumulative volatility and its ROI.
11.
Activity based costing (ABC) is a valuation method that primarily uses scientific and
mathematical methods to evaluate the IT investment process.
12.
Portfolio management is concerned with managing IT assets from an investment perspective
by calculating risks, yields, and benefits.
13.
The value management framework looks at business processes and expected outcomes, and
how IT can enable them.
14.
The balanced scorecard methodology integrates traditional financial measures with customer
perspectives, internal business processes and organizational growth, and learning and
innovation.
15.
A strength of real options is that they reduce risk by permitting deferral of a final
commitment of funds until long-term projects have reduced their uncertainty.
Multiple Choice Questions
16.
Which of the following best describes a technique for assessing the value of IT investments
which calculates net earnings from operations divided by net assets?
a. Modified NPV
b. NPV
c. EVA
d. ROI
Chapter 14 Managing the Information Technology Resource 3
17.
Which of the following best describes a technique for assessing the value of investments
which measures the difference between a division’s (or other activity’s) reported income and
the financial opportunity cost of the division’s investment base?
a. ROI
b. Residual income
c. EVA
d. Real options
18.
Which of the following financial approaches uses recent developments in corporate finance,
especially the capital asset pricing model, to identify the cost of capital for a specific division
or business unit, while attempting to remove distortions created by the GAAP?
a. Modified NPV
b. Residual income
c. EVA
d. Real options
19.
Which of the following best describes an approach used in capital budgeting where the ratio
of present value of the inflows to the present value of the outflow, including the interest
earned during the deferral period?
a. Modified NPV
b. NPV
c. EVA
d. Real options
20.
Which of the following best describes an approach used in capital budgeting where the
present value of cash outflow is subtracted from the present value of cash inflows?
a. Modified NPV
b. NPV
c. EVA
d. Real options
4
21.
Which of the following best describes an IT investment approach which provides an
alternative to defer an investment until some future time?
a. Modified NPV
b. NPV
c. EVA
d. Real options
22.
Which of the following best describes a technique capable of accounting for a firm’s
revisions of its strategies and operations under uncertainty?
a. NPV
b. DTA
c. EVA
d. Real options
23.
Each of the following is considered a limitation of the real options model of investment
valuation except:
a. the model is based on cash flow projections, rather than any intangibles.
b. cumulative volatility adds an explicit incorporation of uncertainty into the model.
c. the risk exposures are increased relative to other valuation models.
d. the complexity of the model may act as a deterrent to IT managers from using it.
24.
According to Buss, each of the following is considered an intangible benefit except:
a. improving client service.
b. speeding up decision making.
c. standardizing manual processes.
d. residual income.
25.
The framework which depicts two elements of value provided by a real option, as
represented by a project’s cumulative volatility and its modified NPV, best describes:
a. a “tomato garden” approach.
b. the investment portfolio approach.
c. the Black-Scholes model.
d. the European call option.
Chapter 14 Managing the Information Technology Resource 5
26.
Which of the following best describes a methodology that measures the cost and performance
of activities, resources, and cost objects?
a. Value management framework
b. Total benefit of ownership
c. Performance measurement
d. Activity-based costing
27.
Which of the following best describes a measure that considers the benefits of competing
products or processes?
a. TBO
b. TCO
c. ABC
d. ABM
28.
Which of the following best describes a measure that determines the total costs associated
with the acquisition and subsequent use of a given item or service from a given supplier?
a. TBO
b. TCO
c. ABC
d. ABM
29.
Which of the following best describes a methodology that integrates traditional financial
measures with customer perspectives, internal business processes and organizational growth,
and learning and innovation?
a. Applied information economics
b. Balanced scorecard
c. Economic value added
d. Portfolio management
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30.
Which of the following best describes a methodology that informs managers what the real
cost of processes are and provides a basis of maximizing profit by encouraging profitable
processes and discouraging unprofitable ones?
a. Value management framework
b. Total cost of ownership
c. Performance measurement
d. Activity-based management
Fill In the Blanks
31.
report their financial information outside of the firm are referred to as GAAP.
32.
The accounting principles that are the generally accepted practices for an organization to
Reference: p. 384
outflow is subtracted from the present value of cash inflows.
Reference: p. 385
33.
The call option that can be exercised only at the date of expiration is referred to as a(n)
Reference: p. 386
34.
under uncertainty best describes a(n) decision tree analysis.
A technique capable of accounting for a firm’s revisions of its strategies and operations
Reference: p. 387
a European call option using the Black-Scholes model for options valuation.
35.
The expressions for the modified NPV and cumulative volatility permit the valuation of
Reference: p. 388
smaller (three to six month) deliverables, ideal for taking advantage of the real option
valuation approach.
Reference: p. 391
37.
A measure that considers the benefits of competing products or processes instead of just
Chapter 14 Managing the Information Technology Resource 7
38.
The management of IT assets from an investment perspective by calculating risks, yields, and
Reference: p. 396
39.
The methodology that calculates “true” economic profit by subtracting the cost of all capital
invested in an enterprise including the technology-from net operating profit best describes
Reference: p. 396
40.
Reference: p. 396
A methodology that integrates traditional financial measures with customer perspectives,
internal business processes and organizational growth, and learning and innovation best
Reference: p. 396
41.
A methodology that quantifies the dollar values of risk and time and adds these into the
42.
The framework that looks at business processes and expected outcomes and how IT can
Reference: p. 397
43.
The method that evaluates intangible costs, benefits, and risks as complements to financial
Reference: p. 400
44.
A methodology that informs managers what the real cost of processes are and provides a
basis of maximizing profit by encouraging profitable processes and discouraging
Reference: p. 400
45.
Uncertainty is measured in real options analysis as the cumulative volatility of the
investment’s future value.
Reference: p. 402
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Essay Questions
46.
Explain a key limitation of using ROI whereby division managers manipulate the ratio in an
attempt to show enhanced short-term results.
47.
Explain the limitations of traditional financial approaches to assessing the value of IT.
48.
Briefly describe the methodology of portfolio valuation and its strengths and weaknesses.
49.
Briefly describe the methodology of real options and its strengths and weaknesses.
Chapter 14 Managing the Information Technology Resource 9
50.
Briefly describe the methodology of information economics and its strengths and weaknesses.