Why Projects Fail: Factors To Consider Before Investing - Microsoft Case Study

Context of UK Investment Appraisal in the UK

Topic

Despite a development cost of over $0.5bn and huge marketing spend of over $700m, Microsoft recently announced that the Windows Vista project had not lived up to expectations.

With reference to the different commercial mistakes that have been reported in the financial pages, you are required to discuss why projects fail.  In the form of a business report for the Director, advise on what a company should consider, both financial and non-financial factors before embarking on an investment.

The business report in here is developed on the firm Microsoft, which is one of the giants within the industry of technology. The study of the provided situation elaborates and highlights the fact that despite of spending a massive development cost of over $0.5bn and massive marketing spending of over $700m (Aabo et al. 2010). This evaluation includes the go through of various financial and non – financial factors that are massively related behind project failures (Hu et al. 2015) (Arnold, 2010).

Investment is one of the major parts that should be managed with intense care by the management of the various firms within the industry to maintain the flow of the business process (Avadhani, 2010). All of these fields can open up exciting business opportunities for the firm. In the meantime, the firm have to abstain from overstretching constrained money related assets or limiting the organization’s capacity to seek after different choices (Brigham and Daves, 2010) (Brigham and Daves, 2010).

Investment appraisal can be defined as a collection of techniques, which are used to identify the attractiveness of an invested amount (Brotman, 2010). Investment appraisal has two major features, which are assessing the expected level of returns (Czaja et al. 2010). The various procedures of evaluating the investment appraisal that Microsoft should have implemented has been stated below:

Discount Rate – The markdown rate is an idea identified with the NPV system. The figuring of the markdown rate can be taking into account various methodologies including(Iatridis, 2010):

• The social rate of time inclination
• The open door expense of capital
• Weighted normal system (Aabo et al. 2010)

The management of Microsoft should have evaluated and studied the above stated elements before starting the project of Windows vista (Finch, 2010).

Internal Rate of Return (IRR) – The IRR is the repayment rates which, when associated to net incomes of a course of action sets them corresponding to the preliminary speculation (Brigham and Daves, 2010). The favoured choice is that with the IRR most prominent in overabundance of a predetermined rate of return (Jorion, 2010). An IRR of 10% implies that with a markdown rate of 10%, the task earns back the original investment (Lewellen, 2015). Likewise, applying distinctive evaluation procedures to the same fundamental information may yield opposing conclusions (Kritzman and Li, 2010).

Investment Appraisal Techniques for Microsoft

Cost Ratio – Cost ratio implies the discounted net revenues separated by the investments at the initial stages. Typically, the project with cost ratio value greater than 1 is preferable (Qin and Singal, 2015). The revenue forecasted or earned by the management of Microsoft was not at all satisfied for their vista project (Madura, 2010). However, the company has invested significant amount of money towards the vista project initially (Brigham and Daves, 2010). The management and the financial managers of have neglected the importance of calculating the cost ratio (Czaja et al. 2010). The cost ratio is also essential for commenting over the economic benefits of the companies (Monks and Lajoux, 2010).

Discounted payback and Payback period – The payback period is typically formulated or considered as one of the sophisticated investment appraisal techniques within the private sectors and estimates the range of duration for taking in order to recover the initial investment (Moore, 2010). However, the company Microsoft and their financial managers are mostly unsure about the payback duration for their vista project (Brigham and Daves, 2010). In addition, the method does not consider time value of money (Schmidgall and DeFranco, 2010). The discounted payback period represents the quantity of time that it requires for covering the cost of the project, by accumulating the net positive discounted cash flows evaluating from the project (Pogue, 2010).

Sensitivity Analysis – Sensitivity analysis or method is the method of developing the financial results regarding the cost advantage analysis that is sensitive towards the supposed financial values taken within the examination (Satyaprasad and Raghu, 2010).  Sensitivity analysis is developed typically for the larger projects such as the windows vista project of Microsoft (Ushijima, 2015). Like other various financial analysis, sensitivity analysis is also recommended for valuing the project of Microsoft Vista (Aabo et al. 2010). The key requirements for the sensitivity analysis are a degree of investigative analysis for ascertaining the most susceptible variables (Scherer, 2010) (Zeng, 2010).

Scenario Analysis – Scenario analysis is also similar to the sensitivity analysis (Shapiro, 2010) (Sharma, 2010).

Distributional Analysis – The NPV calculations creates zero allowances regarding the distribution of the financial costs and financial benefits within the members and society (Smart et al. 2010). The company Microsoft implemented the Microsoft Vista project for meeting the needs and expectations of a particular segment of customers (Czaja et al. 2010) (Thomas and Gup, 2010).

CUA is an alternative method for calculating the cost effectiveness analysis or CEA, which is prepared for estimating the qualified effectiveness of the alternative interventions for achieving two or more than two objectives (Worzala, 2011). Within a cost utility analysis, costs are articulated in terms of monetary, financial benefits are articulated within utility terms, and the outcomes are termed as the quality adjusted life years (Czaja et al. 2010). Cost utility analysis allows comparing the benefits of health interventions without having for implementing a financial value over the health states (Che and Che, 2011).

Main Body That Synthesises Analysis and Evaluation of Examples from the Chosen Organisation

Multi criteria Analysis – The key steps of the multi criteria analysis are as follows:

The first step is to recognise the performance criterion for assessing the Windows Vista project of Microsoft. Secondly, the step follows a plan for scoring a scheme in order to make the Windows Vista project of Microsoft under each principle heading (Aabo et al. 2010). Next, the step follows the allocation of scores towards each investment option against each criterion (Czaja et al. 2010). In addition, the step also follows to calculate overall outcome and test for strength. Finally, the step ends by preparing a report and by interpreting the findings of the analysis (Garrett and James III, 2013).

For analyzing and evaluating these techniques will help understand the effects of the investment on the cash flow (Ross, Westerfield and Jordan, 2013). It will help estimate the benefits of the investment with reference to the total investment cost incurred. The time value of money is ignored while comparing benefits and costs of the investment (Aabo et al. 2010). It is essential for any company to undertake the investment appraisal analysis before deciding to invest huge capital in a new project (Aamer, 2013). Some of the features of the investment appraisal are-

It helps assessing the expected returns level the company is likely to earn from its given expenditure level (Heysel and Filion, 2014).

It helps estimating the future benefits and costs of the project throughout the project life cycle (Hirt and Block, 2012).

It also provides better flexibility and improved production quality (Al-Ajmi, Al-Saleh and Hussain, 2011).

It strives to improve the company image, good job satisfaction and staff morale, which in turn leads to better productivity (Hillier, 2013).

It helps the management in taking quicker and better decisions due to the complete availability of all the investment related information (Al-Khafaji and Al-Khatib, 2011).

In investment appraisal, the cash flows are calculated and compared more than the accounting profits because-

It is difficult to spend the profit (Hirt, Block and Danielsen, 2011).

Profits are more subjective (Jordan, Westerfield and Ross, 2011).

Dividends are paid from the cash flows (Arnold, 2013).

Some of the investment appraisal techniques used here are-

ARR or accounting rate of return- ARR is also known as ROCE or return on capital employed. It is used to compare the profit the company wishes to make from its investment to the total investment amount. The ARR or ROCE is thus the total yearly profits divided by the total capital investment (Barbash and Roye, 2012).

Therefore, ROCE or ARR= Average yearly profits/ Average capital costs*100%

From the annual reports of Microsoft Windows Vista for the accounting year 2008, the total capital invested is development cost of $0.5bn and marketing cost of $700m. Therefore, total investment cost is $500m plus $700m, i.e. $1200m. Total profit from the annual reports is $17681000 (Taillard, 2013).

Therefore, ROCE= $17681000/$1200000000*100=1.47342 =1.47

ROCE is 1.47, which shows that despite making such a huge investment, the company is not able to generate enough profit from its project (Aabo et al. 2010). However, in this method, some of the important information not considered is the project life, cash flows, working capital and the accounting policies (Barrow, 2011).

Payback Period- It is used to measure the time-period within which the initial investment cost is recovered from the cash flows of various years. It helps assess the efficiency of the company to recover the initial cost from cash flows of various years (Robin, 2011). Suppose in case of Microsoft, it launched Windows Vista in 2007 with an initial investment of $1200m. From 2007 to 2015, the cash flows could be $100m in 2007, $150m in 2008, $200m in 2009, $250m in 2010, $300 in 2011, $300 in 2012, $350 in 2013, $400 in 2014 and $450 in 2015 (Bekaert and Hodrick, 2012). Therefore, the payback period is calculated as-

Particulars	Initial Investment	Cash Flow	Cumulative Cash Flows
2007	$                  1,200	$                     100	$                               100
2008		$                     150	$                               250
2009		$                     200	$                               450
2010		$                     250	$                               700
2011		$                     300	$                            1,000
2012		$                     300	$                            1,300
2013		$                     350	$                            1,650
2014		$                     400	$                            2,050
2015		$                     450	$                            2,500

(Berk, 2013) (Brooks, 2013) (Naumov, 2013) (Ramsden, 2011)

From the above table the payback period is somewhere in 2012 which is a total year of 5 years and 4 months. From the assumed data, it can be said that the total payback period for the new project of Windows Vista of Microsoft is quite high in the total time period of 9 years (Moles, 2011). A higher payback period means that the company is not successful in generating enough cash flows from its investment (Brealey, Myers and Allen, 2011).

Using the payback period will help the company get a simple method to deduce the efficiency of the project with respect to the change in technology and investment conditions. It also helps in-

Evaluating the company growth (Peterson, 2012);

Minimizing the risk (Jordan, Westerfield and Ross, 2011);

Maximizing the liquidity (Nicolàs, 2013);

Using the cash flows instated of the profits (Brigham and Houston, 2012).

Cash Flow Methods- The company can also think of using the discounting cash flow methods, which are the NPV and IRR (Carmichael, 2011).

Analyzing the investment sensitivity and risk-

The benefit cost analysis is calculated by dividing the total benefits the company make from a project divided by the total cost the company have to bear to carry out the project (Madura, 2012). When the B/C analysis is show a result more than 1 it means that the company is able to create opportunity from the project but if the BC analysis is less than 1 it means that the company failed to create enough benefits from the investment in the new project (Eun and Resnick, 2012).

For example, in Microsoft, the company had to incur a total investment cost of $1200m in developing Windows Vista and the total benefit earned by the company from the project is $840m. Therefore, the total B/C ratio is $840/$1200= 0.7 (Grieve, 2013).

Conclusion

The current report concludes that the Windows vista project of Microsoft was unable to draw expected return due to various reasons. The initial investments decisions related to the Windows Vista project taken by the management of Microsoft was not profitable entirely. However, the company might have the chance to enhance their profitability or to forecast the actual return based on various financial and non-financial factors that they have completely neglected formulating. The failure of Microsoft for their Windows Vista project could easily be minimised by following various investment appraisal techniques initially, which would indicate the actual return that they should expect from their Windows Vista project.

Masking an effective Investment Appraisal

The key aim will be to justify whether the projects of Microsoft will go to be profitable for their business and whether the project of Microsoft will be able to draw higher amount of return on their investments.

The company Microsoft invested huge amount of money towards their Windows Vista project for meeting various costs associated with the developmental costs and marketing costs.

From the current study, I have learnt various elements of strategic decision-makings.I have learnt that significant amount of investments towards the development and marketing expenses, are not always enough for achieving expected success.

I have also learnt that the company Microsoft is not getting enough sales or customer response as they were targeting the wrong audience for their Windows Vista project.

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