Transcript No Slide Title

Chapter
9
Capital Budgeting: Decision
Criteria and Real Option
Considerations
Copyright ©2003 South-Western/Thomson Learning
Introduction
• This chapter looks at capital
budgeting decision models.
• It discusses and illustrates their
relative strengths and weaknesses.
• It examines project review and postaudit procedures, and traces a
sample project through the capital
budgeting process.
Capital Budgeting Criteria
• Net present value (NPV)
• Internal rate of return (IRR)
• Profitability index (PI)
• Payback period (PB)
Net Present Value
• The net present value—that is, the
present value (PV) of the expected
future cash flows minus the initial
outlay—of an investment made by a firm
represents the contribution of that
investment to the value of the firm, and
accordingly, to the wealth of the firm’s
shareholders.
Net Present Value
• The net present value (NPV) of a
capital expenditure project is defined as
the present value of the stream of net
(operating) cash flows from the project
minus the project’s net investment.
Net Present Value
• The net present value method is also
sometimes called the discounted cash
flow (DFC) technique. The cash flows
are discounted at the firm’s required rate
of return; that is, its cost of capital.
• A firm’s cost of capital is defined as its
minimum acceptable rate of return for
projects of average risk.
Net Present Value
• The net present value of a project may
be expressed as follows:
NPV = PVNCF – NINV
where NPV is the net present value,
PVNCF is the present value of net
(operating) cash flows, and NINV is the
net investment.
Net Present Value
• In general, the net present value of a
project can be defined as follows:
n
NPV  
t 1
NCFt
1 k 
t
 NINV
n
  NCFt  PVIFk ,t  NINV
t 1
where k is the cost of capital, n is the expected
project life, and [NCFt /(1 k )t ] is the arithmetic
sum of the discounted net cash flows for each
year t over the life of the project (n years); that
is, the present value of the net cash flows.
Net Present Value: Example
TABLE 9.1 Sample Project Cash Flows
Year
Project A Net Cash Flow After
Taxes
1
$12,500
2
12,500
3
12,500
4
12,500
5
12,500
6
12,500
Net Investment
$50,000
Project B Net Cash Flow Afte
Taxes
$5,000
10,000
15,000
15,000
25,000
30,000
$50,000
Net Present Value: Example
TABLE 9.2 Sample Net Present Value Calculations: Project A
Present value of an annuity of $12,500 for 6 years at 14 percent:
PV of NCF = $12,500(PVIFA0.14, 6) = $12,500(3.889) = $48,613
Less Net investment $50,000
Net present value $-1,387
Net Present Value: Example
TABLE 9.2 Sample Net Present Value Calculations: Project B
PVIF0.14, t
NCF
Year
1
2
3
4
5
6
Less Net investment
Net present value
$5,000
10,000
15,000
15,000
25,000
30,000
0.877
0.769
0.675
0.592
0.519
0.456
PV of NCF
$4,385
7,690
10,125
8,880
12,975
13,680
57,735
50,000
$7,735
NPV Characteristics
• Decision Rule: NPV > 0 acceptable 
above-normal profits
• Considers the time value of money
• Absolute measure of wealth
– Positive NPVs increase owner’s wealth
– Negative NPVs decrease owner’s wealth
• CFs over the project’s life reinvested at k
• If two or more mutually exclusive
investments have positive net present
values, the project having the largest net
present value is the one selected.
Conditions Allowing AboveNormal Profits
• Buyers preferences for established
brand names
• Ownership or control of distribution
systems
• Patent control of superior product
designs or production systems
• Exclusive ownership of superior natural
resources
Conditions Allowing AboveNormal Profits
• Inability of new firms to acquire factors of
production (management, labor,
equipment)
• Superior access to financial resources at
lower costs (economies of scale in
attracting capital)
• Economies of large-scale production and
distribution
• Access to superior labor or managerial
talents at costs that are not fully
Conditions Allowing AboveNormal Profits
• The net present value of a project can be
thought of as the contribution to the
value of a firm resulting from undertaking
that particular project.
• If a firm identifies projects having
expected positive net present values,
efficient capital markets can quickly
reflect these positive net present value
projects in the market value of the firm’s
securities.
NPV: Advantage
• The net present value of a project is the
expected number of dollars by which the
present value of the firm is increased as
a result of adopting the project. The NPV
method is consistent with the goal of
shareholder wealth maximization.
• The NPV approach considers both the
magnitude and the timing of cash flows
over a project’s entire expected life.
NPV: Advantage
• A firm can be thought of as a series of
projects, and the firm’s total value is the
sum of the net present values of all the
independent projects that make it up.
Therefore, when the firm undertakes a
new project, the firm’s value is increased
by the (positive) net present value of the
new project. The additivity of net present
values of independent projects is
referred to in finance as the value
additivity principle.
NPV: Advantage
• The net present value approach also
indicates whether a proposed project will
yield the rate of return required by the
firm’s investors. The cost of capital
represents this rate of return; when a
project’s net present value is greater
than or equal to zero, the firm’s investors
can expect to earn at least their required
rate of return.
NPV: Disadvantage
• The net present value criterion has a
weakness in that many people find it
difficult to work with a present value
dollar return rather than a percentage
return. As a result, many firms use
another present value-based method
that is interpreted more easily: the
internal rate of return method.
Internal Rate of Return
• The internal rate of return is defined as
the discount rate that equates the PV of
net cash flows of a project with the PV of
the NINV.
• It is the discount rate that causes a
project’s net present value to equal zero.
• The internal rate of return for a capital
expenditure project is identical to the
yield to maturity for a bond investment.
Internal Rate of Return
• A project’s internal rate of return (IRR)
can be determined by means of the
following equation:
n
n
NCFt
NCFt
 NINV  
 NINV  0

t
t
t 1 (1  r )
t 1 (1  r )
where NCFt /(1 + r)t is the present value
of net (operating) cash flows in period t
discounted at the rate r, NINV is the net
investment in the project, and r is the
internal rate of return.
Internal Rate of Return
• NPV versus IRR: The only difference is
that in the NPV approach a discount
rate, k, is pre-specified and the net
present value is computed, whereas in
the IRR method the discount rate, r,
which causes the project net present
value to equal to, is the unknown.
Internal Rate of Return
• Figure 9.1 illustrates the relationship
between NPV and IRR. The figure plots
the net present value of Project B (from
Table 9.1) against the discount rate used
to evaluate its cash flows. Note that at a
14% cost of capital, the net present
value of Project B is $7,735. The internal
rate of return for Project B is
approximately equal to 18.2%. Thus, the
internal rate of return is a special case of
the net present value computation.
Internal Rate of Return: Project A
• The internal rate of return for Projects A
and B can now be calculated. Because
Project A is an annuity of $12,500 for six
years requiring a net investment of
$50,000, its internal rate of return may
be computed directly with the aid of a
PVIFA table, such as Table IV, or with a
financial calculator.
Internal Rate of Return: Project A
• In this case, the present value of the
annuity, PVAN0, $50,000, the annuity
payment, PMT, is $12,500, and n = 6
years. The following equation,
PVAN0 = PMT(PVIFAr,n)
can be rewritten to solve for the PVIFA:
PVIFAr,n = PVAN0  PMT
Internal Rate of Return: Project A
• In this case, PVIFA = $50,000/$12,500 =
4.000. Referring to Table IV and reading
across the table for n = 6, it can be seen
that the interest factor of 4.000 occurs
near 13 percent, where it is 3.998. Thus,
the internal rate of return fro Project A is
about 13 percent.
Internal Rate of Return: Project A
• 6→N
-50,000 → PV
12,500 → PMT
0 → FV (You can skip this step.)
Compute
i% (= 12.98)
Internal Rate of Return: Project B
• -50,000 → CF0
5,000 → CF1
10,000 → CF2
15,000 → CF3
15,000 → CF4
25,000 → CF5
30,000 → CF6
Compute
IRR (= 18.19)
IRR Characteristics
• Decision Rule: IRR > k acceptable
• Generally, the internal rate of return
method indicates that a project whose
internal rate of return is greater than
or equal to the firm’s cost of capital
should be acceptable, whereas a
project whose internal rate of return is
less than the firm’s cost of capital
should be rejected.
• IRR assumes CF is reinvested at IRR.
IRR: Advantage
• The internal rate of return technique
takes into account both the magnitude
and the timing of cash flows over the
entire life of a project in measuring the
project’s economic desirability.
• The greater popularity of the internal rate
of return method may be due to the fact
that some people feel more comfortable
dealing with the concept of a project’s
percentage rate of return than with its
IRR: Disadvantage
• If the pattern of cash flows over the
project’s life contains more than one sign
change (for example, - + + -.), it has
multiple internal rates of return.
NPV versus IRR
• If the NPV and IRR criteria disagree,
NPV is preferred.
• Always agree if NPV > 0, IRR > k;
and if NPV < 0, IRR < k.
NPV versus IRR
• As was indicated, both the NPV and the
IRR methods result in identical decisions
to either accept or reject an independent
project. This is true because the net
present value is greater than (less than)
zero if and only if the internal rate of
return is greater than (less than) the
required rate of return, k (or cost of
capital).
NPV versus IRR
• In the case of mutually exclusive
projects, however, the net present value
and the internal rate of return methods
may yield contradictory results; one
project may have a higher internal rate of
return than another and, at the same
time, a lower net present value.
NPV versus IRR
• Consider, for example, mutually
exclusive projects L and M described in
the following table:
Net investment
Net cash flows
Year 1
Year 2
Net present value at 5%
Internal rate of return
Project L
$1,000
Project M
$1,000
$667
$667
$240
21.5%
$0
$1,400
$270
18.3%
NPV versus IRR
• The outcome depends on what
assumptions the decision maker
chooses to make about the implied
reinvestment rate for the net cash flows
generated from each projects. This can
be seen in Figure 9.2.
NPV versus IRR
• For discount (reinvestment) rates below
10 percent, Project M has a higher net
present value than Project L and
therefore is preferred.
• For discount rates greater than 10
percent, Project L is preferred using both
the present value and internal rate of
return approaches.
• Hence, a conflict only occurs in this case
for discount (cost-of-capital) rates below
NPV versus IRR
• The net present value method assumes
that cash flows are reinvested at the
firm’s cost of capital, whereas the
internal rate of return method assumes
that these cash flows are reinvested at
the computed internal rate of return.
NPV versus IRR
• Generally, the cost of capital is
considered to be a more realistic
reinvestment rate than the computed
internal rate of return because the cost
of capital is the rate the next (marginal)
investment project can be assumed to
earn.
NPV versus IRR
• Consequently, in the absence of capital
rationing, the net present value approach
is normally superior to (both the
profitability index and) the internal rate of
return when choosing among mutually
exclusive investment.
Profitability Index
• The profitability index (PI), or benefitcost ratio, is the ratio of the present
value of expected net cash flows over
the life of a project to the net investment
(NINV). It is expressed as follows:
n
NCFt

t
t 1 (1  k )
PI 
NINV
Profitability Index
• Assume a 14 percent cost of capital, k,
and using the data from Table 9.2, the
profitability index for Projects A and B
can be calculated as follows:
PIA = $48,613/$50,000 = 0.97
PIB = $57,735/$50,000 = 1.15
Profitability Index
• The profitability index is interpreted as
the present value return for each dollar
of initial investment.
• In comparison, the net present value
approach measures the total present
value dollar return.
PI Characteristics
• Decision Rule: PI > 1 acceptable
• A project whose profitability index is
greater than or equal to 1 is considered
acceptable (+NPV), whereas a project
having a profitability index less than 1 is
considered unacceptable (-NPV).
• In the previous case, which project is
acceptable?
• The profitability index considers the time
value of money.
PI Characteristics
• When two or more independent projects
with normal cash flows (for example, - +
+ + ….) are considered, the profitability
index, net present value, and internal
rate of return approaches all will yield
identical accept-reject signals; this is
true, for example, with Projects A and B
in the previous case.
PI Characteristics
• When dealing with mutually exclusive
investments, conflicts may arise
between the net present value and the
profitability index criteria. This is most
likely to occur if the alternative projects
require significantly different net
investments.
PI Characteristics
• Consider, for example, the following
information on Projects J and K.
Present value of net cash flows
Less Net investment
Net present value (NPV)
PI
Project J
Project K
$25,000
$20,000
$5,000
1.25
$14,000
$10,000
$4,000
1.40
• According to the net present value
criterion, Project J would be preferred
because of its larger net present value.
According to the profitability index
criterion, Project K would be preferred.
PI Characteristics
• When a conflict arises, the final decision
must be made on the basis of other
factors. For example, if a firm has no
constraint on the funds available to it for
capital investment—that is, no capital
rationing—the net present value
approach is preferred because it will
select the projects that are expected to
generate the largest total dollar increase
in the firm’s wealth and, by extension,
maximize shareholder wealth.
PI Characteristics
• If, however, the firm is in a capital
rationing situation and capital budgeting
is being done for only one period, the
profitability index approach may be
preferred because it will indicate which
projects will maximize the returns per
dollar of investment—an appropriate
objective when a funds constraint exists.
Payback Period
• Number of years for the cumulative net
cash flows from a project to equal the
initial cash outlay
PB = Net Investment
Annual net CF
When net CFs are unequal,
interpolation is required.
Payback Period
• The payback (PB) period of an
investment is the period of time required
for the cumulative cash inflows (net cash
flows) from a project to equal the initial
cash outlay (net investment).
Payback Period
• If the expected net cash inflows are
equal each year, then the payback
period is equal to the ratio of the net
investment to the annual net cash
inflows of the project:
Net Investment
PB =
Annual net cash inflows
When net CFs are unequal,
interpolation is required.
Payback Period
• When the annual cash inflows are not
equal each year, the analyst must add
up the yearly net cash flows until the
cumulative total equals the net
investment. The number of years it takes
for this to occur is the project’s payback
period.
Payback Period
• One can also compute a discounted
payback period, where the net cash
inflows are discounted at the firm’s cost
of capital in determining the number of
years required to recover the net
investment in a project.
Payback Period
TABLE 9.3 Payback Period Calculations (NINV = $50,000)
Project
A
Year (t)
1
2
3
4
5
6
PB
Undiscounted
Cash
Cumulative
Inflow
Cash Inflow
$12,500
$12,500
12,500
25,000
12,500
37,500
12,500
50,000
12,500
62,500
12,500
75,000
Net Investment/Annual
Cash Inflow
Discounted (at 14%)
Cash Inflow
Cumulative
Cash Inflow
$10,962.50
$10,962.50
9,612.50
20,575.00
8,437.50
29,012.50
7,400.00
36,412.50
6,487.50
42,900.00
5,700.00
48,600.00
# of Years Before Full
Recovery of Net Investment
+ (Unrecovered Initial
Investment at Start of
Year)/(Discounted Cash
Inflow During year)
Payback Period
TABLE 9.3 Payback Period Calculations (NINV = $50,000)
Project B
Year (t)
1
2
3
4
5
6
PB
Undiscounted
Cash
Cumulative
Inflow
Cash Inflow
$5,000
$5,000
10,000
15,000
15,000
30,000
15,000
45,000
25,000
70,000
30,000
100,000
# of Years Before Full
Recovery of Net Investment
+ (Unrecovered Initial
Investment at Start of
Year)/(Cash Inflow During
year)
4 + [(50,000 –
45,000)/25,000] = 4.2 years
Discounted (at 14%)
Cash
Cumulative
Inflow
Cash Inflow
$4,385
$4,385
7,690
12,075
10,125
22,200
8,880
31,080
12,975
44,055
13,680
57,735
# of Years Before Full
Recovery of Net Investment
+ (Unrecovered Initial
Investment at Start of
Year)/(Discounted Cash
Inflow During year)
5 + [(50,000 –
44,055)/13,680] = 5.43
Payback Period
• Table 9.3 illustrates the calculation of
undiscounted and discounted (at a 14
percent required rate) payback periods
for projects A and B, which were
presented earlier in this section.
Payback Period
• In panel (a) of the table we see that the
undiscounted PB period is 4.0 years for
Project A and 4.2 years for Project B. In
panel (b) we see that the discounted PB
period for Project A is undefined. This
occurs because the NPV of the project is
negative, that is, the discounted cash
inflows are less than the net investment.
For Project B the discounted PB period
is 5.43 years.
PB Characteristics
• Decision Rule: The decision criterion
states that a project should be accepted
if its payback period is less than or equal
to a specified maximum period.
Otherwise, it should be rejected.
Payback Period: Advantage
• The payback method gives some
indication of a project’s desirability from
a liquidity perspective because it
measures the time required for a firm to
recover its initial investment in a project.
A company that is very concerned about
the early recovery of investment funds
might find this method useful.
Payback Period: Disadvantage
• First, the (undiscounted) payback
method gives equal weight to all cash
inflows within the payback period,
regardless of when they occur during the
period. In other words, the technique
ignores the time value of money.
Payback Period: Disadvantage
• Assume, for example, that a firm is
considering two projects, E and F, each
costing $10,000.
– Project E is expected to yield cash flows
over a three-year period of $6,000 during
the first year, $4,000 during the second
year, and $3,000 during the third year.
– Project F is expected to yield cash flows of
$4,000 during the first year, $6,000 during
the second year, and $3,000 during the third
year.
Payback Period: Disadvantage
Viewed from the payback period
perspective, these projects are equally
attractive, yet the net present value
technique clearly indicates that Project E
increases the value of the firm more than
Project F.
Payback Period: Disadvantage
• Second, payback methods (both
discount and undiscounted) essentially
ignore cash flows occurring after the
payback period. Thus, payback figures
are biased against long-term projects
and can be misleading.
Payback Period: Disadvantage
• For example, suppose a firm is
considering two projects, C and D, each
costing $10,000.
– It is expected that Project C will generate
net cash inflows of $5,000 per year for three
years. The PB period for Project C is two
years ($10,000/$5,000).
– It is expected that Project D will generate
net cash inflows of $4,500 per year forever.
The PB period for Project D is 2.2 years
($10,000/$4,500).
Payback Period: Disadvantage
• If these projects were mutually
exclusive, payback would favor Project
C because it has the lower payback
period. Yet Project D clearly has a higher
net present value than Project C.
Payback Period: Disadvantage
• Third, payback provides no objective
criterion for decision making that is
consistent with shareholder wealth
maximization. The payback methods
(both discounted and undiscounted) may
reject projects with positive net present
values.
Payback Period: Disadvantage
The choice of an acceptable payback
period is largely a subjective one, and
different people using essentially
identical data may make different
accept-reject decisions about a project.
Payback Period: Disadvantage
• The payback method is sometimes
justified on the basis that it provides a
measure of the risk associated with a
project. Although it is true that less risk
may be associated with a shorter
payback period than with a longer one,
risk is best thought of in terms of the
variability of project returns. Because
payback ignores this dimension, it is at
best a crude tool for risk analysis.
Capital Budgeting Under Capital
Rationing
• For each of the selection criteria
previously discussed, the decision rule is
to undertake all independent investment
projects that meet the acceptance
standard. This rule places no restrictions
on the total amount of acceptable capital
projects a company may undertake in
any particular period.
Capital Budgeting Under Capital
Rationing
• However, many firms do not have
unlimited funds available for investment.
Many companies choose to place an
upper limit, or constraint, on the amount
of funds allocated to capital investments.
This constraint may be either selfimposed by the firm’s management or
externally imposed by conditions in the
capital markets.
Capital Budgeting Under Capital
Rationing
• Step 1: Calculate the PI for projects
• Step 2: Order the projects from the
highest to the lowest PI
• Step 3: Accept the projects with the
highest PI until the entire capital budget
is spent
What Happens When the Next
Acceptable Project is too Large?
• Search for another combination of
projects that increase the NPV
• Attempt to relax the funds constraint
• Excess funds
– Invest in short-term securities
– Reduce outstanding debt
– C/S dividends
Example
• Suppose that management of the Old
Mexico Tile Company has decided to
limit next year’s capital expenditures to
$550,000. Eight capital expenditure
projects have been proposed—P, R, S,
U, T, V, Q, and W—and ranked
according to their profitability indexes, as
shown in Table 9.5.
Example
TABLE 9.5 Sample Ranking of Proposed Projects According to
Their Profitability Indexes
Project
(1)
Net
Investment
(2)
Net
Present
Value
(3)
P
R
S
U
T
V
Q
W
$100,000
150,000
175,000
100,000
50,000
75,000
200,000
50,000
$25,000
33,000
36,750
20,000
9,000
12,500
30,000
-10,000
Present Profitability Cumulative Cumulativ
Value of
Index
Net
Net
Net
= (4)/(2)
Investment
Present
Cash
Value
Flows
(4)
$125,000
1.25
$100,000
$25,000
183,000
1.22
250,000
58,000
211,750
1.21
425,000
94,750
120,000
1.20
525,000
114,750
59,000
1.18
575,000
123,750
87,500
1.17
650,000
136,250
230,000
1.15
850,000
166,250
40,000
0.80
900,000
156,250
Example
• Given the $550,000 ceiling, the firm’s
management proceeds down the list of
projects, selecting P, R, S, and U, in that
order. Project T cannot be accepted
because this would require a capital
outlay of $25,000 in excess of the
$550,000 limit.
Example
Projects P, R, S, and U together yield a
net present value of $114,750 but
require a total investment outlay of only
$525,000, leaving $25,000 from the
capital budget that is not invested in
projects.
Example
• Management is considering the following
three alternatives:
Alternative 1:
It could attempt to find another
combination of projects, perhaps
including some smaller ones, that would
allow for a more complete utilization of
available funds and increase the
cumulative net present value.
Example
In this case, a likely combination would
be Projects P, R, S, T, and V. This
combination would fully use the
$550,000 available and create a net
present value of $116,250—an increase
of $1,500 over the net present value of
$114,750 from Projects P, R, S, and U.
Example
Alternative 2:
It could attempt to increase the capital
budget by another $25,000 to allow
Project T to be added to the list of
adopted projects.
Example
Alternative 3:
It could merely accept the first four
projects—P, R, S, and U—and invest the
remaining $25,000 in a short-term
security until the next period. This
alternative would result in an NPV of
$114,750, assuming that the riskadjusted required return on the shortterm security is equal to its yield.
Example
• In this case, Alternative 1 seems to be
the most desirable of the three. In
rearranging the capital budget, however,
the firm should never accept a project,
such as W, that does not meet the
minimum acceptance criterion of a
positive or zero net present value (i.e., a
profitability index greater than or equal to
1).
Post-Auditing Implemented
Projects
• Find systematic biases or errors of
uncertain projected CFs.
• Decide whether to abandon or continue
projects that have done poorly.
Incorporating Inflation into the
Capital Budget
• Make sure the cost of capital takes
account of inflationary expectations.
• Make sure that future CF estimates
include expected price and cost
increases.
Incorporating Inflation into the
Capital Budget: Example
• Suppose that the Apple Manufacturing
Company has an investment opportunity
that is expected to generate 10 years of
cash inflows of $300,000 per year. The
net investment is $2,000,000. If the
company’s cost of capital is relatively—
say, 7 percent—the net present value is
positive:
Incorporating Inflation into the
Capital Budget: Example
NPV = PVNCF – NINV
= $300,000(PVIFA0.07,10) –
$2,000,000
= $300,000(7.024) – $2,000,000
= $107,200
According to the net present value
decision rule, this project is acceptable.
Incorporating Inflation into the
Capital Budget: Example
• Suppose, however, that inflation
expectations increase and the overall
cost of the firm’s capital rises to say, 10
percent. The net present value of the
project then would be negative:
NPV = PVNCF – NINV
= $300,000(PVIFA0.10,10) –
$2,000,000
= $300,000(6.145) – $2,000,000
= -$156,500  reject
Real Options in Capital Projects
• Investment timing
option
– Evaluate additional
information
• Abandonment
option
– Reduce downside
risk
• Shutdown options
– Temporarily
• Growth options
– Research
programs, expand a
small plant, or
strategic acquisition
• Design-in options
– Input/output
flexibility options or
expansion options
Real Option Information on the Web
• http://www.mbs.umd.edu/finance/
atriantis/RealOptions.html
• http://www.iur.ruhr-unibochum.de/forschung/real_options.html
• http://www.real-options.com/
How are Real Options Concepts
Being Applied?
• Foundation level of use of real options
concept
– Increases awareness of value
– Options can be created or destroyed
– Think about risk and uncertainty
– Value of acquiring additional information
• Analytical tool
– Option pricing models
• Value the option characteristics of projects
• Analyzing various project opportunities
International Capital Budgeting
• Find the PV of the foreign CFs
denominated in the foreign currency and
discounted by the foreign country’s cost
of capital.
• Convert the PV of the CFs to the home
country’s currency.
– multiplying by spot exchange rate
• Subtract the parent company’s NINV
from the PVNCFh to get the NPV.
Amount and Timing of Foreign CFs
• Differential tax rates
• Legal and political constraints on CF
• Government-subsidized loans
Small Firms
• Should be the same as large firms
• Discrepancies
– Lack experience to implement procedures
– Expertise stretched too thin
– Have cash shortages
• Focus on the PB