The story that we will tell in the following sections takes place in a small business. At present, the management is contemplating an investment project. The owner of the firm, Mr. Grr., has delegated the managing authority to Mr. Y who, despite a more than obvious lack of decision making capability, has run the firm fairly successfully. One should note his analytical brain power as particularly favorable. Moreover, however, time and again he proves to be quite bossy. (In his scarce spare time Y enjoys watching American day-time TV-series.)
Conventional methods of capital budgeting include static as well as time-adjusted techniques. In the case study we will trace the path that leads from static profit comparison to time-adjusted techniques of preinvestment analysis. We start with a short refresher on conventional time-adjusted methods. In doing so, we will draw special attention to the influence of the discount rate on the target figures. This way, in good time, the reader will become aware of the importance of developing a concept that does not require the use of a discount rate.
Up till now DY11 only has had to compete with a possible financial investment of the initially available internal funds. In our case study business something special is about to happen: DY11 will have to face a real competitor. Which consequences will this have for our investment appraisal? We will deal with this question in this chapter.
Even if we consider the foundations of capital budgeting with VOFIs as firmly established, there still remains a number of questions to be dealt with. To keep you from waiting for too long, we end this short introduction to the fourth chapter now. After all, the dazzling parameter ‘discount rate’, which had confused Dr. X in section 3, has to be examined.
Meanwhile Y had become a Virtuoso Of Financial Implications. And thus when doing the annual tax assessment he immediately realized how limited the previous preinvestment analysis had been — they had omitted tax payments due! He called his expert Dr. X and said: “Good morning Mr. X! [Y did tax assessment at night — it was 4 a.m.] The visualization we have done is incomplete! We didn’t include tax requirements! It’s about time to start visualizing the taxation implications — we need a VOFATI! After all, we’re not living in a world without taxes.”
Shortly before Christmas of the year t=0 (Y and Dr. X were just making a VOFI for a new scenario) the owner of the business, Mr. Grr., unexpectedly showed up and had the following announcement to make:
