1. Use the Internet to access the home page for the City of Chicago, www.cityofchicago.org. Use the Programs and Initiatives link to access information about various capital projects underway in the city government. When this text went to press, these initiatives included such categories as Environment, Housing, Technology, and Transportation.
Required: Read about one or more of these capital projects, and then discuss how the organization's managers should go about making significant decisions about expenditures for major capital projects like the one you have explored. (If you prefer, complete a similar requirement for a different city of your choosing.)
2. DYSFUNCTIONAL FOCUS
ON EARLY CASH FLOWS
The timing of cash flows in investment decisions can sometimes create behavioral incentives to make dysfunctional decisions. The following hypothetical scenario presents such a situation.
The Institute for Environmental Studies (IES) is a privately funded, nonprofit scientific organization based in Montreal. The organization's director of field research is scheduled to retire in two years, and the assistant director, Marie Fenwar, is hoping to be appointed to the post at that time. In her current position, Fenwar has significant administrative responsibilities, including the approval of research proposals and equipment acquisitions. Fenwar has developed a reputation for carefully scrutinizing every proposed project and keeping the institute's field research branch within its budget. Fenwar has been so successful in her job that she has been quietly assured by several members of the IES board of directors that she is in line for her boss's job. She knows, however, that her prospects depend on her continued success in keeping the field research branch in solid financial shape. IES recently signed a contract with the U.S. and Canadian governments to do a five-year study of the effects of global warming on the migration of water fowl. The contract fee is $500,000, payable in equal annual installments over the contract term. Fenwar is now considering two alternative proposals for carrying out the study. Each proposal entails the purchase of equipment and the incurrence of various operating costs throughout the term of the contract. Fenwar's normal procedure for project evaluation is to calculate each proposal's NPV, using an 8 percent hurdle rate. The projected costs follow:
Year Type of Cost Research Proposal I Research Proposal II
Time 0 Equipment acquisition* $ 40,000 $70,000
Year 1 Operating costs 150,000 75,000
Year 2 Operating costs 120,000 75,000
Year 3 Operating costs 75,000 95,000
Year 4 Operating costs 40,000 95,000
Year 5 Operating costs 40,000 95,000
* The equipment will be obsolete at the end of the contract term.
Fenwar calculated an NPV of $1,370 for Proposal I and $(14,375) for Proposal II. After completing her NPV analysis, however, Fenwar was tempted to ignore it. These thoughts ran through her mind as she drove to work: "If I approve Proposal I, the financial picture for the field research branch is going to pieces for the next two years. After a $40,000 initial investment in equipment, I'm going to show losses of $50,000 and $20,000 in the first two years. That's not going to look very good when the board considers my promotion." When she arrived at the office, Fenwar wrote a memo approving Proposal II.
Question. Which research proposal should Fenwar have accepted? Why? Comment on the ethical issues in this scenario.