Project Feasibility Decision

Project teams need to select projects that maximize returns and minimize the opportunity costs. 1. Discuss the importance of using the decision tree in making project feasibility decision to accept or reject.
Decision tree is one of the tools used to analyze the economic feasibility of projects. A significance importance of using the decision tree is that this method considers risks in the evaluation of projects. In finance, risk refers to a decision-making environment where outcomes are not known with certainty, but their probabilities can be determined (Brash, 2003).
The decision tree method does not use a single cash flow forecast but consider the possibility of getting different cash flows under different conditions. The method then focuses of establishing the probability for each state of nature and then uses these probabilities to compute the expected monetary value (Besley & Brigham, 2007). The decision tree recognizes that it is not realistic to forecast the cash flows from a given project with certainty. Therefore, this techniques considered different possibilities and use them to compute the expected monetary value of the project. This appraisal technique also reflects the time value of money as cash flows are discounted to their present value when evaluating the projects.
The decision tree is also a transparent method for analyzing projects. The graphic presentation of options and their probabilities create and communicate how different yet uncertain scenario can play out and their financial implication (Harris, 2012). It is an effective tool that assists project appraisers to consider the effect of multiple scenarios on the value of a given project.
2. Discuss pros and cons of using "gut feeling" in making project feasibility decision.
Gut feeling method of making feasibility decision entails the use of the evaluator’s judgment to in coming up with a decision. A significant pro of using gut feeling in assessing the feasibility of projects is that this method does not hinder innovation or creativity (Harris, 2012). It is difficult to estimate cash flows where the projects involve finding a total new product, services, concept or production process. In most case, firms have to use gut feeling in assessing the feasibility of these projects. Another merit linked to this appraisal technique is that it does not consume a lot of time since not much data is required for computation and decision-making. The method is also easy and practicable.
The use of gut feeling has its flaws including subjecting the project evaluation process to the subjective views of the decision maker. The gut feeling method of assessing feasibility is not objective as the assessor relies on his experiences, skills, beliefs, and expectations to make a decision (Harris, 2012). It is also a cost-sensitive technique of analyzing projects; hence, is suitable for small projects that do not justify heavy investment in feasibility studies. The use of gut feeling to appraise the feasibility of a given project also make it difficult for the project team to enlist the support of stakeholders such as creditors (Mercken, 2005).
3. Discuss the significance of internal rate of return (IRR) in making project feasibility decision.
The internal rate of return (IRR) is the rate that provides a net present value of zero when used to discount the cash flows of a given project (Besley & Brigham, 2007). The IRR is a common method of assessing the feasibility of projects. The evaluator arrives at a decision by comparing the IRR with the company’s required rate of return if the project is independent. The evaluator accepts the project if the IRR is greater than the required rate of return. For projects that are mutually exclusive, the evaluator selects the project with the highest IRR.
The IRR has several advantages including that the method considers the time value for money. Computing the IRR entails discounting cash flows to their present value; hence, the method considers issues such as opportunity cost and cost of capital (Harris, 2012). The IRR also has an advantage over methods such as the accounting rate of return because the IRR uses cash flows rather than accounting profits. The use of cash flows gives consistent results than the use of profits since the computation of profits is subject to different accounting standards. A noteworthy downside of this method is that it is difficult to compute. IRR also fails to consider the reinvest plan of the business (Arshad, 2012).
4. Discuss the use of opportunity cost in making project feasibility decision.
The opportunity cost refers to economic benefits that would be generated from resources that of the firm provided these resources are not used in another project (Besley & Brigham, 2007). Opportunity cost is computed by getting the difference between the net value of the selected project and the net value of an alternative project that was not selected. Opportunity cost is a key concept in capital budgeting. When evaluating the feasibility of a given project, one must considers the economic benefits of other projects that will be foregone when the firm decides to invest in this particular project.
Project teams need to select projects that maximize returns and minimize the opportunity costs. Considering opportunity costs enable the project evaluator to make effective decisions. This concept ensures that project are not selected on the basis of their return only but also on the basis of other projects (Harris, 2012). It encourages the project selection team to use a holistic approach while selecting projects rather than consider projects independently. It encourages the project team to consider the effect of selecting a given projects on other projects within the organization.

Besley, S. & Brigham, E. (2007). Essentials of managerial finance. USA; Cengage Learning
Brash, M. (2003). Real option in practice. USA; John Wiley & Sons
Harris, P. (2012). Strategic project risk appraisal and management. USA: Gower Publishing Ltd
Mercken, R. (2005). IT investment decisions: Value, gut feeling and uncertainty. Tijdschrift voor Economie en Management. 50 (4), 83- 92

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Submitted On Dec 28, 2017. Viewed 35 times.

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