"I can’t believe that we should not enter this promising emerging market", Ben Appoloni, the CEO of Gamma Tools, said during the company’s recent investment meeting. His CFO has explained that opening a new plant in Brazil would be a value-destroying project, as the net present value of this project is negative.
Appoloni knows that he should only invest if there is a positive payoff. But he is also convinced that the huge level of uncertainty about the payoff and the ability of Gamma Tools to flexibly react to any new situation can make a difference.
Strategically, he feels that the investment is absolutely compelling. But how can he convince his CFO about the financial advantages of this project? Does his CFO’s investment valuation tool really provide an accurate result, given that there is so much uncertainty?
Indeed, traditional investment valuation tools use techniques like discounting future cash flows to calculate the value of new projects. However, these techniques fail to incorporate uncertainty and managerial flexibility to react to uncertain outcomes in the valuation procedure.
Decision tree analysis is an important alternative that addresses these shortcomings of traditional investment valuation tools. Using this approach, Appoloni will be able to identify the real value of projects with a high level of uncertainty and the opportunity to react.
This is of particular importance for strategic investments such as new growth opportunities. By using the decision tree analysis, Appoloni may be able to convince his organization’s CFO that a strategic investment provides positive financial payoff.
Have you ever been in a situation in which you are convinced about a business opportunity, but you didn’t receive approval because you weren’t able to prove the financial payoff? The Accenture Academy course Managing Uncertainty and Flexibility Using Decision Trees highlights the shortcomings of traditional tools for making investment decisions and discusses the advantages of decision trees. You will learn how to use decision trees for valuing uncertain projects, thereby creating value for your organization.