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Evaluating Projects at Nexcom Systems
Nexcom Systems develops information technology systems for commercial sale. Each year it considers and evaluates a number of different projects to undertake. It develops a road map for each project in the form of a decision tree that identifies the different decision points in the development process from the initial decision to invest in a project’s development through the actual commercialization of the final product.
The first decision point in the development process is whether or not to fund a proposed project for one year. If the decision is no, then there is no resulting cost; if the decision is yes, then the project proceeds at an incremental cost to the company. The company establishes specific short-term, early technical milestones for its projects after one year. If the early milestones are achieved, the project proceeds to the next phase of project development; if the milestones are not achieved, the project is abandoned. In its planning process, the company develops probability estimates of achieving and not achieving the early milestones. If the early milestones are achieved, then the project is funded for further development during an extended time frame specific to a project. At the end of this time frame, a project is evaluated according to a second set of (later) technical milestones. Again the company attaches probability estimates for achieving and not achieving these later milestones. If the late milestones are not achieved, the project is abandoned.
If the late milestones are achieved, this means that technical uncertainties and problems have been overcome and the company next assesses the project’s ability to meet its strategic business objectives. At this stage the company wants to know if the eventual product coincides with the company’s competencies, and if there appears to be an eventual clear market for the product. It invests in a product “prelaunch” to ascertain the answers to these questions. The outcomes of the prelaunch are that either there is a strategic fit or there is not, and the company assigns probability estimates to each of these two possible outcomes. If there is not a strategic fit at this point, the project is abandoned and the company loses its investment in the prelaunch process. If it is determined that there is a strategic fit, then three possible decisions result. (1) The company can invest in the product’s launch and a successful or unsuccessful outcome will result, each with an estimated probability of occurrence. (2) The company can delay the product’s launch and at a later date decide whether to launch or abandon. (3) If it launches later, then the outcomes are success or failure, each with an estimated probability of occurrence. Also, if the product launch is delayed, there is always a likelihood that the technology will become obsolete or dated in the near future, which tends to reduce the expected return.
The table provides the various costs, event probabilities, and investment outcomes for five projects the company is considering.
Determine the expected value for each project and then rank the projects accordingly for the company to consider.
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