Question

You are encouraged to research outside sources and, of course, cite them. Do not, however, quote sources word-for-word, but rather, respond to the Discussion Forum Question in your own words.

1.     Identify four reasons that capital budgeting decisions by managers are risky.

2.     Why is an investment more attractive to management if it has a shorter payback period?

3.     Why should managers set the required rate of return higher than the rate at which money can be borrowed when making a typical capital budgeting decision?

4.     Why does the use of the accelerated depreciation method (instead of straight line) for income tax reporting increase an investment’s value?

After you’ve completed the questions above, please provide a brief explanation of how this information is important in managerial decision making. (500 minimum word count, references excluded)

Answer 1

1. The reasons why the capital budgeting decisions made by the managers are risky are as follows:

1. Managers are focused on mainly important factors like the cost of the investment that is to be made, the prevalent rate of interest and the projected or expected cash flows that would arise as a result of the investment. This however doesn’t take into account certain other factors and that may result in the managers concentrating only on short term results while ignoring the long term impact of the investment.
2. Managers do not take into account the inflation and the prevailing tax rates. In the event that the inflation and the tax rates rise in the future the cash flows that arise would be different i.e lesser than the amount actually predicted.
3. Managers may not fulfill their corporate social responsibility by avoiding any allocations towards ethical and environment issues as this will not positively highlight the performance of the departments headed b y the managers and that would have an adverse effect on the current goals.
4. Managers do not allocate funds in order to make the investments as it would have an adverse impact on the profits and also the bonuses that accrue to the managers.