3. Creighton Inc. is preparing a bid to sell a large telephone communications system to a major business customer. It is characteristic of the telephone business that the vendor selling a system gets substantial follow-on business in later years by making changes and alterations to that system. The marketing department wants to take an incremental approach to the bid, basically treating it as a capital budgeting project.

They propose selling the system at or below its direct cost in labor and materials

(the incremental cost) to ensure getting the follow-on business. They’ve projected the value of that business by treating future sales less direct costs as cash inflows.

They maintain that the initial outlay is the direct cost to install the system, which is almost immediately paid back by the price. Future cash flows are then the net inflows from the follow-on sales. These calculations have led to an enormous NPV and IRR for the sale viewed as a project.

Both support and criticize this approach. (Hint: What would happen if Creighton did most of its business this way?)