1 of 1 The timing of cash flows in investment decision can sometimes create behavioural incentives to make dysfunctional decisions. The following hypothetical scenario presents such a situation. The Institute for Environmental Studies is a privately funded, non-profit scientific based in organization Montreal. The organization's director of field research is scheduled to retire in two years, and the assistant director, Marie Fenwar, is hoping to be appointed to the post at that time. In her current position, Fenwar has significant administrative responsibilities, including the approval of research proposals and equipment acquisitions. Fenwar has developed a reputation for carefully scrutinizing every proposed project and keeping the institute's field research branch within its budget. Fenwar has been so successful in her job that she has been quietly assured by several members of the IES board of directors that she is in line for her boss's job. She knows, however, that her prospects depend on her continued success in keeping the field research branch in solid financial shape. IES recently signed a contract with the U.S. and Canadian governments to do a five-year study of the effects of global warming on the migration of water fowl. The contract fee is $500,000, payable in equal annual instalments over the contract term. Fenwar is now considering two alternative proposals for carrying out the study. Each proposal entails the purchase of equipment and the incurrence of various operating costs throughout the term of the contract. Fenwar's normal procedure for project evaluation is to calculate each proposal's NPV, using an 8 percent hurdle rate. The project costs follow: Year Type of Cost 0 1 2 3 4 LO Equipment acquisition* Operating costs 5 Operating costs Operating costs Operating costs Research Proposal I $40,000 150,000 120,000 75,000 40,000 Operating costs * The equipment will be obsolete at the end of the contract term. Research Proposal II $70,000 75,000 75,000 40,000 95,000 95,000 95,000 Fenwar calculated NPVs for both proposals. After completing her NPV analysis, however, Fenwar was tempted to ignore it. These thoughts ran through her mind as she drove to work: "If I approve Proposal I, the financial picture for the field research branch is going to pieces for the next two years. After a $40,000 initial investment in equipment, I'm going to show losses in the first two years. That's not going to look very good when the board considers my promotion." When she arrived at the office, Fenwar wrote a memo approving Proposal II. Requirements: Unaware to Marie Fenwar, the BOD has asked you, the Management Accountant, for an independent review. a. Evaluate Fenwar's selection of Proposal II. (Hint: Consider which research proposal Fenwar should have accepted and why) b. As the Management Accountant, highlight at least 3 courses of action you would recommend to the BOD concerning Marie Fenwar.

The timing of cash flows in investment decision can sometimes create behavioural incentives to make dysfunctional decisions. The following hypothetical scenario presents such a situation. The Institute for Environmental Studies is a privately funded, non-profit scientific organization based in Montreal. The organization's director of field research is scheduled to retire in two years, and the assistant director, Marie Fenwar, is hoping to be appointed to the post at that time. In her current position, Fenwar has significant administrative responsibilities, inciuding the approval of research proposals and equipment acquisitions. Fenwar has developed a reputation for carefully scrutinizing every Fenwar calculated NPVs for both proposals. proposed project and keeping the institute's After completing her NPV analysis, however, field research branch within its budget. Fenwar was tempted to ignore it. These Fenwar has been so successful in her job that thoughts ran through her mind as she drove to she has been quietly assured by several work: "If I approve Proposal I, the financial members of the IES board of directors that she picture for the field research branch is going to is in line for her boss's job. She knows, pieces for the next two years. After a $40,000 however, that her prospects depend on her initial investment in equipment, l'm going to continued success in keeping the field research show losses in the first two years. That's not branch in solid financial shape. going to look very good when the board considers my promotion." When she arrived at IES recentiy signed contract with the US. and the office, Fenwar wrote a memo approving Canadian governments to do a five-year study Proposal II. of the effects of global warming on the migration of water fowl. The contract fee is Requirements: $500,000, payable in equal annual instalments Unaware to Marie Fenwar, the BOD has asked over the contract term. Fenwar is now you, the Management Accountant, for an considering two alternative proposals for independent review. carrying out the study. Each proposal entails a. Evaluate Fenwar's selection of Proposal II. the purchase of equipment and the incurrence (Hint: Consider which research proposal of various operating costs throughout the term Fenwar should have accepted and why) of the contract. Fenwar's normal procedure for b. As the Management Accountant, highlight projectevaluationistocalculateeachproposalsNPV,usingan8percenthurdlerate.atleast3coursesofactionyouwouldrecommendtotheBODconcerningMarie Fenwar