Chapter 2 Solutions

Exercises
1. You manage a hotel resort located on the South Beach on the Island of Kauai in
Hawaii. You are shifting the focus of your resort from a traditional fun-in-the-
sun destination to eco-tourism. (Eco-tourism focuses on environmental
awareness and education.) How would you classify the following projects in
terms of compliance, strategic, and operational?
a. Convert the pool heating system from electrical to solar power.
b. Build a 4-mile nature hiking trail.
c. Renovate the horse barn.
d. Replace the golf shop that accidentally burned down after being struck
by lightning.
e. Launch a new promotional campaign with Hawaii Airlines.
f. Convert 12 adjacent acres into a wildlife preserve.
g. Update all the bathrooms in condos that are 10 years or older.
h. Change hotel brochures to reflect eco-tourism image.
i. Test and revise disaster response plan.
j. Introduce wireless Internet service in café and lounge areas.
How easy was it to classify these projects? What made some projects more
difficult than others?
Most students classify the projects as follows:
Compliance: d., g., i.

Operational: a., c., j.
Strategic: b., e., f., h.
Most students claim it was not too difficult to classify the projects other than they had
to make judgment calls given the limited information. In real life they would have
such information. Debates occur around whether converting the heating system to
solar polar was an operational necessity or to fit the eco-friendly image. Likewise,
launching the promotional campaign with Hawaii Airlines would be considered
strategic if it promoted the eco-tourism theme, otherwise it could be consider
operational.
What do you think you now know that would be useful for managing projects at
the hotel?
By classifying the projects, prioritizing is more easily done. Different selection

criteria can be used for selecting strategic versus operational projects. Financially,
senior management would have more information to divide the total money pie
allocated to projects.
2. Two new software projects are proposed to a young, start-up company. The
Alpha project will cost $150,000 to develop and is expected to have annual net
cash flow of $40,000. The Beta project will cost $200,000 to develop and is
expected to have annual net cash flow of $50,000. The company is very
concerned about their cash flow. Using the payback period, which project is
better from a cash flow standpoint? Why?
Payback = Investment / Annual Savings
Project Alpha: $150,000 / $40,000 = 3.75 years
Project Beta: $200,000 / $50,000 = 4.0 years
Project Alpha is the better payback.
4. You work for the 3T company, which expects to earn at least 18 percent on its
investments. You have to choose between two similar projects. Your analysts
predict that inflation rate will be a stable 3 percent over the next 7 years. Below
is the cash flow information for each project. Which of the two projects would
you fund if the decision is based only on financial information? Why?
Omega Alpha
Year Inflow Outflow Netflow Year Inflow Outflow Netflow
Y0 0 $225,000 -225,000 Y0 0 $300,000 -300,000
Y1 0 190,000 -190,000 Y1 $50,000 100,000 -50,000
Y2 $150,000 0 150,000 Y2 150,000 0 150,000
Y3 220,000 30,000 190,000 Y3 250,000 50,000 200,000
Y4 215,000 0 215,000 Y4 250,000 0 250,000
Y5 205,000 30,000 175,000 Y5 200,000 50,000 150,000
Y6 197,000 0 197,000 Y6 180,000 0 180,000
Y7 100,000 30,000 70,000 Y7 120,000 30,000 90,000
Total 1,087,000 505,000 582,000 Total 1,200,000 530,000 670,000
2 PROJECT MANAGEMENT: THE MANAGERIAL PROCESS

A B C D E F G H I J
1
2 Exercise 4a
3 Net Present Value Example Comparing Two Projects
4
5 Project Omega Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7
6 Required Rate of Return 18%
7 Investment -$225,000
8 Cash Inflows -$190,000 $150,000 $190,000 $215,000 $175,000 $197,000 $70,000
9 NPV = $119,689 Formula Project Omega: =C7+NPV(B6,D8:J8)
10
11 Project Alpha Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7
14 Cash Inflows -$50,000 $150,000 $200,000 $250,000 $150,000 $180,000 $90,000
15 NPV = $176,525 Formula Project Alpha: =C13+NPV(B12,D14:J14)
16
17 NPV comparison: Accept both Omega and Alpha; or select Alpha that has the highest NPV of $176,525
18
19 Exercise 4b
20 Net Present Value Example Comparing Two Projects (with inflation)
21
22 Project Omega Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7
25 Cash Inflows -$190,000 $150,000 $190,000 $215,000 $175,000 $197,000 $70,000
26 NPV = $76,650 Formula Project Omega: =C24+NPV(B23,D25:J25)
27
28 Project Alpha Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7
31 Cash Inflows -$50,000 $150,000 $200,000 $250,000 $150,000 $180,000 $90,000
32 NPV = $129,536 Formula Project Alpha: =C30+NPV(B29,D31:J31)
33
34 NPV comparison: Accept both Omega and Alpha; or select Alpha that has the highest NPV of $129,536
Chapter 2 Organization Strategy and Project Selection 3

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Exercises

Most students classify the projects as follows:

Compliance: d., g., i.

By classifying the projects, prioritizing is more easily done. Different selection

Payback = Investment / Annual Savings

Project Alpha: $150,000 / $40,000 = 3.75 years

Project Beta: $200,000 / $50,000 = 4.0 years

Project Alpha is the better payback.

2 PROJECT MANAGEMENT: THE MANAGERIAL PROCESS

Chapter 2 Organization Strategy and Project Selection 3

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