Question

Capital budgeting – how corporations make the decision to commit millions of dollars to a project. If companies utilize the proper decision techniques with qualified analysts, why do some projects fail? Using the examples of bad investments, what do companies need to understand about how capital budgeting works in the real world? As a leader in your organization, what strategies can you implement to improve the chance of successful projects?

Answer 1

Capital budgeting is a complex and sensitive process by which a business evaluates the investments that are large in nature. Firms use various methods of capital budgeting such as npv analysis IRR, discounted cash flow and payback period analysis to determine the viability of a capital project. This involves careful Research and estimation of the amount of revenues that would be generated up on taking up a capital project. The firm also needs to estimate the incremental cost of taking up the project. The opportunity cost which is generally the cost of capital of the business is determined and used to arrive at the net profitability that would be derived from a capital project.

Despite careful analysis with the help of qualified analysts the projects fail due to incorrect estimations of risk involved. There may also be a rose in estimation of the amount of working capital needed for the rate of return on the project. Besides errors that could be changes in prices taxation policies and government policies which may make the capital project in effective.

Identification of all possible options that are available for making the capital investment is a complex but important step in the capital budgeting process.

Speed of implementation is key in making an effective investment decision. As leader of the organisation I would pay special attention to the planning phase of the capital expenditure. This would involved careful analysis of all available options and evaluation of the same. Constant supervision and review is required. I would stress upon establishment of business performance standards and objectives and a transparent line of communication between all people involved in the project to ensure its success.