Evaluating Approaches to Making Business Decisions

Making decisions, whether in business or personal life, involves a form of tradeoff. A choice of one decision implies the loss of benefits that alternative decisions may have provided. In this respect, making decisions in an environment with multiple alternatives requires careful deliberation to ensure that the decision arrived at is one that offers maximum benefits.  Such benefits may be in enhancing value, or in reducing the extent of loss that could arise from taking the specific course of action. Even in non-financial decisions, most decisions will usually involve a tradeoff; for example, a decision to go for advanced studies may come at the expense of spending time with friends and family. In such a case, one will need to evaluate the value of spending time with family against that of furthering one’s education to come to a prudent decision. In making financial decision, similar tradeoffs occur and, in most cases, a decision that appears the most attractive may fail to have significant benefits over other alternatives when aspects such as future value, initial cost, and rate of return on investment are considered. The purpose of this paper is thus to highlight various processes of decision-making through a case-study analysis. The case study used concerns personal finance and investing decisions.

Case Presentation

Background

Ms. Xena Chapman comes from a family of entrepreneurs. Her grandfather, Marcus George was a visionary businessman. When Marcus was 25 years of age, he started a courier company right from his garage. This had arisen from his observation that many of his friends and colleagues in employment always complained of the inefficient service by the country’s Postal Service. By the time Marcus reached the age of 45, his business had expanded to provide not only courier services across the country, but also shipping services for light packages in 10 countries. The effort he had to put to see his business succeed and challenges he had faced such as getting operating licenses in various regions being fresh on his mind, Marcus had decided to initiate his two sons and a daughter to the corporate world early enough. His eldest son, Chapman, pursued training in business administration to the postgraduate level and had gone on to become the CEO of the family business when Marcus health started failing. The other son, Edward, and daughter, Valerie, headed different divisions of the firm; Valerie was the human resource manager, and Edward the chief financial officer.

However, Marcus had gone ahead and provided a fund for his grandchildren in the event his children mismanaged the family’s business. The fund, managed by trustees, was to be divided equally among the grandchildren to cater for their education in the event of the parents’ inability, with any remainder being provided to each grandchild on attaining the age of 24. The grandchildren were to use such residual money as they pleased. Ms. Xena, being on her final year in campus and a few months to turn to 24, was expectant of receiving her lump sum. Ms. Xena’s claim had accumulated to approximately $0.4 million. She was eager to receive the money, but her father’s advice to “invest the money wisely” had made her nervous about making a wrong choice. Although her grandfather would have helped her make a prudent decision since they were very close, he was no longer there to assist after succumbing to illness. Ms. Xena felt that were she to invest unwisely and lose the money, she would have failed her grandfather who had worked quite had to ensure the financial security of the family.

Decision Elements: Objectives, Alternatives, Consequences, Uncertainties

Although Ms. Xena and her father enjoy a good relationship, she felt that she needed to move away from her parents’ home. She estimated that she could get a good house to purchase with approximately $250,000 following her research on home prices in the area she hoped she would settle. Further, she intended to spend about $70,000 to buy a car that would facilitate her mobility. She perceived that were she to take such a decision, she would need the remainder to pay for expenses at her new abode, and to return for her graduate studies. She estimated that after completing her 2-year graduate studies, chances were that she would secure a job paying at least $ 110,000, which would attract a tax of about $33,000.

Before leaving the university, one of Ms. Xena’s friends convinced her to attend a business seminar held in the campus for one week. Although, she did not attend all the sessions, one of the sessions that caught her attention was about investment opportunities availed via various instruments. Particularly, Ms. Xena was interested in a 12%, 2-year fixed investment offered by the Treasury, which paid interests bi-annually and offered the advantage of exemption from state and local taxes (U.S. Department of the Treasury, Bureau of the Public Debt, 2012). Ms. Xena opined that if she invested the entire amount there, stayed at her parents’ home for two more years, and took a job with the family’s business at a salary of $40,000, she would have adequate funds to buy a the house and start a marketing agency. She believed that she could save as much as a quarter of her net annual salaries towards this venture. With such a salary level, she estimated that her taxes would amount to approximately $13000 p.a.  She estimated that she would need about $600,000 for startup activities, hire staff and pay for advertising services for the first year. Of these expenses, she estimated that 50% would go to advertising, 35 percent to staff salaries, and the remainder for startup activities and emergency fund. She projected sales of $400,000 during the first year, and had estimated that, with her marketing skills and business acumen, she could increase her revenues by 10% each subsequent year. Such growth would necessitate hiring of more staff but, as the business grew, the advertising costs would come down since. The high initial advertising costs were occasioned by Xena’s intent to have many media campaigns during the first 6 months of the business. She believed that, if she attained a significant number of customers in the first year, she would concentrate on customer retention activities facilitated by her interactive website and social media marketing, which she believed would lower her advertising costs to 20 percent of the revenues (Bernoff, 2009). In such a new structure, the other operating expenses inclusive of staff salaries would triple the expenditure on advertising, with staff salary taking up 80 percent of such triple amount.  Xena contended that she would only be interested in the business if it offered at least a 20 percent margin by the third year of operation, which she perceived would be sufficient to offset the opportunity presented by continued investment in the 12% fixed income treasury notes.

A third alternative for Xena was to buy the $70,000 car, stay at her parent’s home, work at the family’s enterprise at the salary proposed and invest the remainder of the money in ordinary shares of XYZ Ltd. XYZ Ltd. was a software company listed in the stock market. With the remaining amount, Xena could purchase 6600 shares of XYZ Ltd. Her research revealed that the company had paid a dividend of $3.05 per share for the last five years. She was very convinced that, unless new disruptive technologies were invented, the company would maintain its dividend payout ratio for the foreseeable future. Xena was attracted to the shares of XYZ Ltd. more after assessing the trend of its share prices. She observed that the shares had doubled in price over the preceding two-year period. More so, Xena observed that the entity had already acquired a competitor who had threatened to lower XYZ’s profitability that year. Xena approximated that if the company continued its strong performance, she could sell her shares at 75% above the purchase price she paid for after five years.

Decision to be made

Xena intends to take the decision that will offer the highest value for her money in five years from the time of receiving the lump sum. She estimated that since the housing market has improved after the crisis (International Monetary Fund; IMF, 2013), the house she intends to buy will appreciate marginally at 2% p.a. She also estimated that the car would depreciate at 20 percent per annum with any residual value being deductible in a trade-in for a new car. Since Xena would only enter into a business that offered a margin of 20%, she realized that, in the first instance, she had to evaluate the profitability of the proposed business.

Decision Analysis

References

Bernoff, J. (2009, July 20). Advertising will change forever: digital spending will nearly double in 5 years, but ad budgets won’t. Advertising Age. Retrieved December 13, 2010, from http://adage.com/digitalnext/post?article_id=138023

International Monetary Fund (2013). IMF country report No. 13/236: United States. Retrieved from http://www.imf.org/external/pubs/ft/scr/2013/cr13236.pdf

U.S. Department of the Treasury, Bureau of the Public Debt (2012). Treasury notes. Retrieved from http://www.treasurydirect.gov/indiv/products/prod_tnotes_glance.htm

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