They stated that, in both situations, no investment costs to the organization are incurred and therefore it is impossible to compute capital budgeting estimates of utility, such as return on investment.
To address this criticism, we must carefully define the concept of investment and then distinguish it from the cost concept more familiar to psychologists conducting utility analyses. To help clarify this distinction, we describe three types of alternative choice problems faced by managers who must decide on alternative courses of action within the human resource function (Anthony & Reece, 1983). The first type of alternative choice problem involves consideration of the costs of alternative courses of action. The second type of problem involves consideration of both revenues and costs. This is the problem that Hunter et al. (1988) described in their two examples. The third type of problem involves investment as well as revenues and costs. The capital budgeting model of utility proposed by Cronshaw and Alexander (1985) is congruent with this third type of alternative choice problem but not with the first two types.
Three key terms are incorporated into the preceding description of alternative choice problems: cost, revenu...
Cost refers to the amount of resources used for any purpose (Anthony & Reece, 1983). Costs incurred in an accounting period are either assets or expenses. An asset is defined as a cost that yields benefits to the organization beyond the current accounting period (usually 12 months). For example, a machine that is expected to have a useful life of 10 years is classified as an asset because it is expected to produce outputs (such as machined parts) that benefit the organization by bringing in revenue over a long period of time (in this case 10 years). An expense is defined as a cost that yields benefits to the organization only within the current accounting period. For example, the cost of electricity for the machine for one month is classified as an expense because the resulting benefits accrue only over the short term. This distinction between accounting for a cost as an asset or as an expense has important implications, which are discussed shortly. Revenue refers to the inflow of funds that results from the sale of goods and services to the firm's customers. An investment is the acquisition of an asset resulting in a future stream of expected cash inflows (i.e., revenues). For the example of the machine purchase given earlier, parts produced with the machine would be sold to customers, and the resulting stream of revenues would be received over the 10-year life of the machine. Normally, investment in an asset is made in a lump sum (which Cronshaw and Alexander, 1985, called original cost) at the beginning of a project.
Conventional utility analyses used by industrial psychologists (e.g., Cronbach & Gleser, 1965; Schmidt, Hunter, McKenzie, & Muldrow, 1979) often contain terms for both revenue and cost.