Chapter 4 – Capital Budgeting
Slide 20
Slide 20 describes the highlights of the Corporate Nudges box on page 98. The
content of the slide involves what is known as the outside view. Managers who take the
outside view look at their situation as if they were external consultants, on the outside as
it were. In the outside view, managers focus not so much on the project details, but on
how successful are other managers doing other projects. In the outside view, managers
Slide 21
Slide 21 pertains to aversion to a sure loss. Managers whose behavior reflects this
phenomenon are prone to resist terminating losing projects, instead choosing to throw
good money after bad. The slide makes the points that capital budgeting techniques are
used more frequently for new projects than for decisions about continuing existing
projects.
Chapter 4 – Capital Budgeting
Slide 23
Slide 23 describes the highlights of a situation at the consumer electronics firm
Sony that took place in the 1960s. The gist of the situation is that Sony managers built a
plant dedicated to the production of color television sets before they had developed a cost
effective manufacturing process. They also had promoted the product, and consumer
demand was very strong. Instead of terminating the project, which was losing money
cost fallacy: aversion to a sure loss, visibility, and regret. However, the situation at Sony
also illustrates overconfidence and excessive optimism on the part of Ibuka.
Instructors might want to ask their students if they believe that the root cause of
Ibuka’s resistance stems from a compensation package that did not adequately address an
agency conflict? Certainly, Ibuka had a personal interest in developing new technology
Slide 25
Slide 25 describes the highlights of a situation that occurred at the pharmaceutical
firm Syntex during the 1980s. At that time, the majority of Syntex’s revenues came from
a single drug, Naprosyn, that was due to go off patent in 1993. Syntex’s managers were
©2018 McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the
classroom. No reproduction or further distribution permitted without the prior written consent of
McGraw-Hill Education.
15
1977.
In the mid-1980s, Syntex’s scientists began to observe that enprostil had a
negative side effect profile. The drug’s indications suggested that it might cause blood
clots, strokes, and heart attacks, any of which might be fatal. John Fried, who was
president of the research division at the time strongly resisted terminating enprostil. In
particular, he displayed confirmation bias. He asked that Syntex scientists rewrite the
Instructors might mention that when Naprosyn went off patent, Syntex sold the
drug over the counter as Aleve. Naprosyn was the brand name of naproxen, a drug
mentioned in chapter 1. Instructors might ask their students if they recall the context in
which naproxen arose. The context was a clinical trial in which Merck’s drug Vioxx and
naproxen were paired in the VIGOR clinical trial. Instructors might ask students if they
see any similarities between the situation at Merck with Vioxx and the situation at Syntex
Chapter 4 – Capital Budgeting
Slide 25
Slide 25 pertains to corporate nudges associated with the sunk cost fallacy. After
instructors have presented the contents of the slide, they might ask students if the advice
offered seems reasonable. The questions on the slide are intended to help managers come
to terms with a loss, and to understand that the reluctance to terminate a project reflects
Slide 27
Slide 27 revisits the issue of agency conflicts. Instructors might ask students if
John Fried’s reluctance to terminate enprostil appeared to have stemmed from a
compensation package whereby his interests were not aligned with shareholders? Like
Ibuka at Sony, Fried was a major shareholder in his firm.
Instructors might ask students if they recall an agency conflict issue with Syntex’s
CEO Paul Freiman? That conflict stemmed from Freiman having used Syntex’s corporate
Chapter 4 – Capital Budgeting
Additional Resources for Chapter 4 Available on the Web
On the book web site, instructors will find additional resources that relate to
Chapter 4. This material is intended for instructors who wish to delve into the main
Suggested Answers to Minicase Compusys
1. Draw up a list of the behavioral features you perceive in the case of Config, and
indicate where in the case these features occur. If you perceive there to be
multiple occurrences of a particular feature, list each occurrence separately.
Chapter 4 – Capital Budgeting
— Excessive optimism and overconfidence were at work.
— Given the problems identified in the paragraph, the underlying cash flows were
excessively optimistic.
At the end of 1983, Config was still not operational in the firm’s sales offices.
Moreover, salespeople on the project complained vigorously that the engineers
Chapter 4 – Capital Budgeting
©2018 McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the
classroom. No reproduction or further distribution permitted without the prior written consent of
McGraw-Hill Education.
19
—The bolded comments indicate that engineers suffered from confirmation bias, and
ignored disconfirming evidence.
Chapter 4 – Capital Budgeting
In 1985, the project engineers managed to link Config and the price quotation
system used by the salespeople. However, those salespeople who used the system
found it more time consuming to produce price quotes than the salespeople who
did not. One sales representatives made the following comments: “When you get
done with Config and want to print a quote, you create a file, transfer a file, you
— In 1982 the project team prepared a discounted cash flow analysis that indicated a net
present value of $43.9 million (20 percent discount rate) for the five-year period FY82-
FY86. Notably, a second financial analysis was undertaken in 1985, and it showed the net
present value of Config to be $55.7 million, discounted at 20 percent, for the five-year
Chapter 4 – Capital Budgeting
As events unfolded, Compusys executives described the reactions of Tom Jones
and George Smith. “When have done surveys of people in the field, the
information we got wasn’t what Jones and Smith wanted to hear, but their denial
has been so powerful. Their response has been: ‘Wrong answer, we don’t like that
answer.’ They never listen to negative feedback. When I approach Smith with
—If there was any doubt, the bolded comments show that it’s overconfidence stemming
from confirmation bias.
—Implicit aversion to a sure loss.
A third financial analysis conducted in 1987 indicated that the net present value of
Config was at least $41.1 million for the five-year period FY87-FY91. Yet by
1990, Config had yet to catch on with the sales force. Moreover, many executives
Chapter 4 – Capital Budgeting
based on the usage patterns, I didn’t think anybody would miss Config very much
if we fumed it off tomorrow. If CompuSys has spent millions on this project, we
have really missed the boat. I argued that we should pull the plug on this effort
immediately. The people responsible for developing Config are trying to breathe
—Aversion to a sure loss. Refusing to ignore sunk costs. Continued crying over spilled
milk. Project visibility.
In 1992, Tom Jones died, and George Smith left Compusys. A new Vice President
evaluated the Config project and concluded: “What are we doing? We’re
spending a lot of money on something that nobody really wants. Stop.” And so
the project was terminated. Subsequently, managers provided their impressions
about the why Config had been adopted, and why it continued. One manager
Chapter 4 – Capital Budgeting
see them in front of us at the moment. So there was a kind of technological
optimism.” A second manager offered the following view: “Even though we
sometimes got a cold reception from Sales, it continued to be funded anyway as
an R&D project. As along as Tom Jones was in charge, Config never got
—Home runs and learning to be overconfident from past successes.
—Excessive optimism recognized after the fact.
—Never got reviewed by overconfident managers.
—“Regardless of what the data said” implies confirmation bias.
2. Discuss any parallels between the case of Config and examples described in the
chapter.
Chapter 4 – Capital Budgeting
©2018 McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the
classroom. No reproduction or further distribution permitted without the prior written consent of
McGraw-Hill Education.
24
Answer: The two pertinent examples in the text are Sony and Syntex. In both examples,
managers were reluctant to terminate losing projects. Compusys, Sony and Syntex all
featured overconfident executives who championed visible projects that began to fail. In
Compusys and Syntex, confirmation bias was a strong contributor to the decision to
continue the projects.