Believe it or not there are companies out there that make $50 million dollar mistakes. “How ABC Was Used in Capital Budgeting” examines how one Fortune 500 company almost made what could have been an extremely devastating $50 million dollar mistake by carrying out a “cybermall” project based on favorable business case forecast results. Luckily, upper management was willing to allow their Chief Financial Officer to conduct further analysis before making this investment decision.
This article examines an industry leader that, in the 1990s, was looking for the next big business opportunity in the electronic market place. With nothing else out there like a “cybermall” bringing buyers and sellers together in the comfort of any television marketplace, senior management believed their “speed to market” with this project would really give them an edge. Revenues would be generated from the rents charged to sellers in this marketplace, as well as advertisers that wished to place their advertisements on the site. Capital investments of $50 million were expected over the initial 10 years of implementing this project, mostly for infrastructure and network development, database and application development, and other minor deployment related activities. Based on a simple overview, or a business case forecast, this “cybermall” project appears to be a good investment with healthy expected profits and positive net cash flows, which initially appeared enticing to upper management.
The CFO being all too familiar, however, with the overly optimistic picture that can be painted by a broad strategic analysis insisted this projected be broken down, tactically translated and analyzed for risk potentials. The CFO didn’t employ just any method of analysis; he used an activity based cost (ABC) model (with benchmarking) to forecast business activities, revenues, and operating and capital costs more precisely then had been done with the business case forecast. The ABC model...
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