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Chapter 12 – Strategy and the Analysis of Capital Investments
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Chapter 12 – Strategy and the Analysis of Capital Investments
Teaching Notes for Readings
Reading 12-1: How Forest Product Companies Analyze Capital Budgets
This article presents the result of a survey on the uses of capital budgeting techniques by forest product
companies. Capital budgeting for this industry has become more challenging and riskier because of
increasing competitiveness and government and environmental pressures. The survey shows that 1) there
has been a significant increase in the use of the DCF method for all capital investment decisions, 2)
quantified risk analysis has taken on increased importance, 3) more firms implement post audit
procedures as a way to both monitor and control their capital investment, and 4) other procedures such as
breakeven analysis, probability analysis, and decision tress are coming into use as relevant capital
budgeting methodologies.
Chapter 12 – Strategy and the Analysis of Capital Investments
Discussion Questions:
Question 1: The survey result shows that more firms use one or more discounted cash flow methods
in evaluating timber-related investments. However, more firms use payback period to evaluate
plant and equipment purchases. What might be the reasons for these differences?
The survey found the 76% of the firm used a DCF method for time-related investments compared to
55% of plant and equipment purchases. The reason might be that time-related investments are longer
Question 2: List changes in the uses of capital budgeting techniques over the years.
Among the changes over the years observed in the survey are:
1. A much higher percentage of the forest products firm uses one of the discounted cash flow
Question 3: List some of the methods for adjusting risks in capital investments.
Common methods for adjusting capital projects for risk are adjusting the cost of capital used in
discounting cash flows or as the cutoff rate, adjusting the project life, and conducting sensitivity
analysis to determine the allowable ranges of variation of expected revenues or costs.
Question 4: What is a post-audit? How do forest product companies conduct post-audits?
A post audit compares the actual results of a capital project with the original forecasts that were used
in making the capital investment decision.
reported to the board. Most firms conducted post audits on only the first year results.
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Education.
