Professor Rosilyn Overton | Chapter 9 – Making Capital Investment Decisions
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Chapter 9 – Making Capital Investment Decisions

Special Assignment!

Extra Credit–Not Required

Do an internet search to find out what happened in the AOL -Time Warner merger. Note the URLs of the places that you found interesting.  Write a half-page to a page on the following questions.
Who took over whom?
What do you think about the corporate cultures of the two companies?
Given that AOL was enjoying phenomenal growth, do you think that you would have thought it was overpriced AT THE TIME?

One of the problems you may have thought of as we worked in Chapter 8 was how do we know that projected cash flows are accurate? Certainly, I would expect someone who was passionate about a proposed project to be more optimistic about it than perhaps was really warranted, not because he or she was trying to cheat, but simply because “Love is blind.”


For example, a problem of evaluation that is much in the news these days in Time Warner and AOL. With the clarity of 20/20 hindsight, people are criticizing this merger/acquisition on the basis that the AOL stock was overvalued, and many are blaming Steve Case. In fact, Steve Case, who was President of AOL at the time, did exactly what he should have done — he used stock that was priced high (AOL) to purchase stock that was priced low. (Time Warner). That the projected profits of the AOL division evaporated with the Internet bubble shows that the guys at Time Warner made an error — not Steve Case. This is a case of billions of dollars, and the best and brightest managers at the company that publishes Time magazine and owns all the Bugs Bunny, Yosemite Sam, Tweety Bird and Taz cartoons clearly made an error. You, however, will be able to do better than they did by the end of this chapter!



When you finish your study of this chapter, you should know:


  1. Determine the cash flows for a proposed investment
  2. Analyze a projects projected cash flows and determine if they are realistic.
  3. Evaluate an estimated NPV in the same manner.

The following are terms that you should be able to define perfectly when you finish studying this chapter. Make your flash cards and take them with you, reviewing them whenever you have a chance. You will be a happy test taker!


Key terminology:

Accelerated Cost Recovery System
Capital rationing
Contingency planning
Forecasting risk
Hard rationing
Incremental cash flow

Managerial options
Opportunity cost
Pro forma financial statements
Scenario analysis
Sensitivity analysis
Soft rationing
Stand-alone principle
Strategic options
Sunk cost



Study Guide questions
Chap. 1-9
Chap 10-16


Don’t forget! Homework is due by 6:30 PM on class day by e-mail to! Don’t suffer a zero by being late.