Introduction to Finance

SWOT analysis
examines a fi rm’s 
s
trengths, 
w
eaknesses, 
o
pportunities, and 
t
hreats. 
With it, managers can identify capital budgeting projects that allow the fi rm to exploit its 
competitive advantages or prevent others from exploiting its weaknesses. 
Strengths and weaknesses come from the fi rm’s internal abilities, or lack thereof. Strengths 
give the fi rm a comparative advantage in the marketplace. Perceived strengths can include 
good customer service, high-quality products, strong brand image and customer loyalty, 
innovative research and development (R&D) eff orts, market leadership, or strong fi nancial 
resources. Once identifi ed, strengths can be used to correct or mitigate a fi rm’s weaknesses. 
Weaknesses give competitors opportunities to gain advantages over the fi rm. The fi rm can 
select capital investments to mitigate or correct weaknesses that have been identifi ed. For 
example, a single-country producer who fi nds it diffi
cult to compete in a global market can 
achieve global economies of scale (that is, achieve “global scale”) by making investments that 
will allow it to export or produce its product overseas. 
CRISIS
Opportunities and threats represent external conditions that aff ect the fi rm, such as 
competitive forces, new technologies, government regulations, and domestic and international 
economic trends. The 2007–2009 Great Recession aff ected economies and fi rms around the 
globe. Those fi rms with strong brands and adequate liquidity survived; others, such as General 
Motors, Chrysler, and AIG, needed government bailouts or they went bankrupt, as did Bear 
Stearns. As another example of this eff ect, in recent years consumers have tended to favor 
“green” technology and have been willing to pay a premium price for it. Changing environ-
mental regulation and government-sponsored regulations have been opportunities to some 
(wind energy fi rms) and threats to others (coal-fi red utility plants).
Where do positive NPV projects come from? From economics, we learn that economic 
profi ts in a competitive market are zero (recall that zero economic profi t implies that the fi rm 
is earning a fair accounting return on its invested capital). In a competitive marketplace, we 
should be suspicious of any capital budgeting project that appears to have a positive net present 
value. Any positive economic profi t or positive NPV must arise from one or two sources. One 
source is a market imperfection or ineffi
ciency (such as an entry barrier or monopoly situation) 
that prevents competition from driving the NPV to zero. The second source of a positive NPV 
might involve cost-saving projects that allow the fi rm to reduce costs below their current level. 
Events that could cause such a situation to exist for a project include the following:
1) 
Economies of scale and high capital requirements
typically go together. High sales 
volumes are sometimes needed to cover large fi xed costs of plant and equipment. Scale 
economies occur as average production cost declines with rising output per period. Any new 
entrant must have available fi nancing to construct a large-scale factory and be able to sell in 
suffi
cient quantity to be cost competitive—requirements that can prevent entry and promote 
positive net present values for investments by existing fi rms.
2) 
Product diff erentiation
can generate positive net present values. Diff erentiation comes 
from consumers’ belief in there being a diff erence between fi rms’ products, whether or not