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LONG TERM INVESTMENT DECISIONS

Cheryl Thomas Strayer University

Assignment 3/Long-Term Investment Decisions

Dr. Camille Castorina

August 30, 2014

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One of the most important long term decisions for any business relates to investment.

Investment is the purchase or creation of assets with the objective of making gains in the future.

Typically investment involves using financial resources to purchase a machine/building or other

asset, which will then yield returns to an organization over a period of time. Planning

investments involves thinking about a range of issues that have a bearing on where you

ultimately decide to put your money. These issues will vary according to your particular age,

circumstances and attitude to risk, and thinking about them carefully before you start making

commitments will help you avoid some potentially costly mistakes.

1. Outline a plan that managers in the low-calorie microwaveable food company could
follow when selecting pricing strategies for making their products as inelastic as possible.
Provide a rationale for your response.

Pricing the product to reach out the current and potential customers is crucial for the

managers. It is their understanding and decisions that are going to determine the success of any

business. A major strategy that ensures that customers are retained with the product is to make

the product inelastic employing pricing and other strategies. However, before we explain the

strategies to make low-calorie microwavable food inelastic, we must understand the meaning of

elasticity.

Elasticity or price elasticity is a measure of quantity demand responded when price is

changed, that is, it a measure of responsiveness of the consumer due to price change. It is

measured as the ratio of the percentage change in the quantity demanded and percentage change

in price. If the elasticity of demand is greater than one, we say that demand is elastics, if it is less

than one, we say that demand is inelastic, if equal to one, we say demand is unit elastic.

Inelasticity basically implies that the product is a necessity to the consumer, so even if the price

goes up, consumer will not respond with an equi-proportionate decrease in quantity demanded.
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In this case we have found out that the price elasticity is -0.61 which means a 1% increase in

price of the product causes quantity demanded to drop by 0.61%. So, the demand of the product

is relatively inelastic. However, from a long run perspective, it is important for the managers to

ensure that inelasticity remains for the benefit of the company.

So the first strategy will be to identify the segment of the customer for which low calorie

microwavable product is necessary and focus on offering services and benefits to these segments

which tie them to the product for a long time. The managers need to make sure that their

competitors cannot lure the customers with benefits and services that will offer substitutes to the

customers, as one of the ways to make a product inelastic is having less number of alternatives.

Reducing the cost will also help the company by which they can pass on the benefit of cost

reducing by keeping the price low and thereby maintaining the customer base. Innovation,

variety and reaching out to a wide customer base will also help in long run to keep the product

inelastic.

2. Examine the major effects that government policies have on production and
employment. Predict the potential effects that government policies could have on your
company.

As a business manager it is very important to understand the impact of government

policies on the business. In an economy, policies from several levels can affect the business.

Federal, state, and local governments are involved in the regulation of business enterprises. At

Federal level we have Federal Trade Commission and Antitrust Division of the including many

other agencies that regulate business decisions. State regulations comprise of regulation of public

utility companies and licensing of various businesses, such as health care facilities, and

numerous professions, such as law and accounting. Similarly, Local governments frequently set

and enforce zoning laws and building codes. Regulatory constraints can be imposed in non-
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discriminatory ways on any set of similar business. These constraints can affect a firms

operating costs (both fixed and variable), capital costs, and revenues. So, when the firms cost is

increased due to some form government regulation, that might lead to decreased production and

hence less number of hiring.

In this case of the microwavable food, there are several firms who are producing food

which are slightly different from each other, a situation that can be characterized as product

differentiation. This is a classic example of a monopolistically competitive market. Now

according to FDA, it is required that the reference amount for an imitation or substitute food or

altered food, such as a low calorie version, should be the same for the food for which it is offered

as a substitute. So if the firm in order to capture the market violates the regulation that would

affect the firm.

3. Determine whether or not government regulation to ensure fairness in the low-calorie

microwavable food industry is needed.

Low- calorie microwavable food industry has been characterized as monopolistic

competitive industry. When industry sales are concentrated in a few hands, market conduct and

performance are less likely to be competitive in nature. One widely used index of market

concentration is the market concentration ratio. It may be defined as the percentage of total

industry output (measured in terms of sales, employment, value added, or value of shipments)

attributable to the 4, 8, 20, or 50 largest companies. Companies acting alone can be charged

under the Sherman Act with illegally attempting to monopolize a market or engage in

monopolistic practices. So, there if the industry is only concentrated in few hands, fairness would

require government intervention. Similarly fairness can be violated when the industry practices

price discrimination.
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A large company that operates as a manufacturer or distributor in two (or more) different

geographic (or product) markets and cuts wholesale prices in one market and not in the other

market can be accused under the Robinson-Patman Act of engaging in illegal price

discrimination. Differential pricing directly to final product customers is allowed (and often

based on what the market will bear) but not so in pricing to intermediate product resellers

(wholesalers, distributors, etc.).

4. Cite the major reasons for government involvement in a market economy. Provide two
(2) examples of government involvement in a similar market economy to support your
response.

Governments interfere in the market because of economic and social reasons. Regulations

become desirable if the intervention results into marginal benefit exceeding the marginal cost of

that intervention. Similarly, when market may not provide the most efficient outcome, there

might be a need to supplement it with government regulation. Again, another important aspect is

consideration of ensuring equity or fairness in the decision making process. It is important that

government regulations benefit the poor, however, there is always a change of trading off equity

with efficiency.

It is believed that unregulated market can sometime lead to inefficiency or as commonly

referred to as market failure. For example consider the markets for water, power, and

telecommunications. In such situations a natural monopoly can provide the services most

efficiently, but that would create market power and unregulated profits. Hence in almost every

economy there is a regulatory control in such markets that limits utility prices and profits.

Similarly, there might be considerable differences in terms of private costs and values and

social costs and values from the production and consumption of certain goods and services. This

difference is often referred as externality. One example of negative eternality is environmental

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pollution and in such a scenario regulatory provisions like carbon tax can here play important

role in balancing the negative impacts of pollution.

5. Examine the major complexities that would arise under expansion via capital projects.
Propose key actions that the company could take in order to prevent or address these
complexities.

All the companies aspire to become big and for that think of expanding the business

horizon. Hence it is paramount that firms managers think of the long run and distribute

resources to increase productive capacity, create mechanism to improve cost efficiency, and

diversify the asset base of the company. It is however, important to note that any decision taken

by the managers involve risk and generally would impact not only the current cash flows but also

future costs as well as benefits. Capital budgeting is a process that involves long term planning,

requires proper mechanism to evaluate capital expenditures which essentially demands research

and developments, education and training for employee, lease-versus-buy decisions, and

decisions regarding mergers and acquisitions.

The complexities involved in expansion and capital budgeting need careful and

concentrated efforts and the following steps could be taken in order to address these

complexities. First, managers should generate alternative capital investment project proposals

and try to democratize the process of generating the ideas for new capital investments.

Involvement of all the stakeholders in generating new ideas, from factory workers all the way up

to the board of directors, will certainty help in reducing the complexities. It is also important to

have an estimate of the cash flows for project proposals. And following guidelines can certainly

help in estimating such cash flows;

1. Cash flows that is measured on an incremental basis, i.e. for any project the cash flow stream
should be represented by the difference between the cash-flow streams to the firm with and
without acceptance of the investment project.
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2. Cash flows should be measured on an after-tax basis, using the firms marginal tax rate.

3. All the indirect effects of the project throughout the firm should be included in the cash-flow
calculations. For example, if a department or division of the firm is contemplating a capital
investment that will alter the revenues or costs of other departments or divisions, then these
external effects should be incorporated into the cash-flow estimates.

4. Sunk costs should not be considered when evaluating the project. A sunk cost is an outlay that
has been made (or committed to be made). Because sunk costs cannot be avoided, they should
not be considered in the decision to accept or reject a project.

5. The value of resources used in the project should be measured in terms of their opportunity
costs.

So, the third part is evaluating the feasibility of the project. Typically, a project will result

in an initial (first-year) outflow (investment) followed by a series of cash inflows (returns) over a

number of succeeding years and there could be several criteria to assess the feasibility of a

project: be it Internal rate of return or Net Present value. Finally, a comprehensive review of the

projects to check the accuracy of the decisions and if needed, a mid-course correction.

6. Suggest the substantive manner in which the company could create a convergence
between the interests of stockholders and managers. Indicate the most likely impact to
profitability of such a convergence. Provide two (2) examples of instances that support your
response.

It is quite natural to have a conflict of interest between the managers and shareholders.

Hence, it is important that managers are able to identify such potential conflicts and provide

solutions to these conflicts. The major problem comes from the distribution of profit among the

managers and shareholders. While shareholders would want the profit to be distributed as

dividends, managers would want this as bonus.

Here, there requires the synergy of interest between these two groups. One strategy would

be to offer deferred stocks to the managers which entitle the holder to purchase company stock at

a slight discount to its current. So these are linked to performance of the manger and provided as

bonus. If the firms performance subsequently improves, capitalized value rises and both
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shareholders and the managers stand to gain. In 2009, CEO compensation in Fortune 500

companies averaged $7 million, 71 percent of which involved deferred-stock or options-based

compensation for superior performance. Similarly, Procter & Gamble places more than $3 billion

per year in advertising through Saatchi & Saatchi, Leo Burnett, and other ad agencies.

Traditionally, agencies earned flat-rate fees assessed as 15 percent of the ad dollars expended for

the client. In the 1990s, Ford,

Colgate-Palmolive, and P&G broke out of this flat-rate system and began paying a

baseline fixed fee plus a performance bonus. Now, account executives at the agencies earn a

fixed salary if their creative communications are less than compelling and P&G sales stay flat.

On the other hand, a hugely successful ad campaign can earn multimillion-dollar bonuses if

P&Gs sales growth can be attributed to the advertising. Both the clients, the ad agency owners,

and the account execs now share in the risks of consumer whimsy, but a base salary provides a

safety net should random misfortune occur.

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Conclusion

In conclusion, different investments obviously carry different risks; these risks need to be

balanced against the potential rewards. There is a wide choice of asset classes and financial

instruments to choose from, and it falls to the individual investor to understand the risks by doing

their homework, reading the documentation, etc before making any investment decisions.

Taking an optimistic view towards investments can impede judgment and lead to higher risks

being taken. Make rational decisions based on your initial goals. The need to make sure you base

your investment decisions on clear reasoning sounds so obvious that its hardly worth pointing

out. Yet its something many people find surprisingly hard to do consistently in practice.
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References

Mankiw, G. N., (2012). Principles of Microeconomics (6th ed.) . Cengage Learning

McGuigan, J. R., Moyer, R. C., & Harris, F. H. deB. (2014). Managerial economics:

applications, strategies and tactics (13th ed.). Stamford, CT: Cengage Learning

Nicholson, W. (2012). Microeconomic Theory: Basic Principles and Extensions (11th ed.).

USA: Cengage Learning.

Samuelson F. W. & Marks, G.S. (2012). Managerial Economics (7th ed.). Wiley

Varian, H. R. (2011). Intermediate Microeconomics: A Modern Approach (8th ed.). NY: Norton