Question

1. “Since capital budgeting decisions involve the estimation of a project’s future cash flows and the rate at which they should be discounted is still a relatively subjective process, the behavioral traits of managers still affect this process.” Discuss this statement and suggest how managers can better improve their ability to eliminate biases in their forecasting.

Answer 1

Capital budgeting refers to process of evaluation and selection of investments that coorelate with the organisations goal. It inclues Evaluation of projects that relate to organisational objectives, Estimation and evuation of cash flows for projects and selection of appropriate project that gives maximum return.The discount rate under which cash flows should be discounted is also estimated. Present value of cash flows is calculated and compared with investment. All these process involves degree of estimation by managers which effects this process.

There are many ways that can help managers to improve their ability such as managers should make the best use of their ability in estimation of cash flows since they are most important part of evaluation. Cash flows should be estimated after taking all the conditions and factors prevailing in the industry.Mangers should use different approaches to get the best rate which should be used to discount cash flows after taking all the risks related. Manager should also analyze which method sould be used to calcute return in the peoject Such as NPV, IRR, PAYBACK PERIOD ARR etc.