Question

QUESTION ONE

Serina Bay Valley (SBV) Ltd. is evaluating whether it should produce a new synthetic steel that will require billions of dollars to develop. According to Bill Bates, the CEO of SBV LTD, the synthetic steel should substantially boost both the sales and net income of SBV Ltd. Mary, who has worked in the capital budgeting area for six years, has been asked to estimate the relevant cash flows that the synthetic steel is expected to generate.

During the past few weeks, Mary has had quite a few conversations with the company’s engineers, production manager and vice president of marketing. With the information she compiled through her conversations with the aforesaid people and additional information she received from independent sources, Mary put together a detailed forecast of the synthetic steel’s relevant cash flows. The final report, which includes only the forecasted cash flows and explanations for the forecasts, was submitted to the chief investment officer yesterday. The report does not include NPV or IRR analysis of the new product because such analyses are conducted by the investment officer.

Today, the investment officer called Mary to tell her that he thought that the forecasts she submitted were incorrect. Mary explained that her forecasts were based on a large amount of data that she had collected and corroborated in combination with analysts’ predictions concerning the potential success of the synthetic steel. As she told the investment officer, her forecasts were based on optimistic growth rates in sales for the synthetic steel during the next 15 years. The investment officer said that he thought the growth of such a revolutionary product could be higher than Mary estimated. The investment officer asked her to reconsider her cash flow estimates. Although she had reviewed the numbers dozens of times and Mary is convinced that her forecasts are reliable, Mary agreed to go over the forecasts one more time. Being a team player is important to Mary because she wants to move up the corporate ladder as quickly as possible, and she believes that her rise to the executive suite will be enhanced if she cooperates with her superiors, including the investment officer.

Because she set up her forecast on a spreadsheet, Mary knew it would be easy to change the growth rate of sales to get new cash flow forecasts for the synthetic steel. However, Mary did not think that growth rates higher than the ones she used in her original forecasts could be achieved, even if the synthetic steel proved to be a huge success.  Despite this, she used the higher growth rates that the investment officer had suggested and generated a new set of forecasted cash flows for the synthetic steel. Even though she is convinced that the new growth rates are likely not attainable, Mary sent her new forecasts to the investment office a little while ago.  She figured, ‘What’s the difference? I don’t make the final decision anyway’.

1. Identify the ethical dilemmas in the above stated situation.
2. Was it appropriate for the investment officer to request Mary to change her cash flow estimates?
3. Was it appropriate for Mary to change her cash flow estimates?
4. What would you do if you were Mary?

Answer 1

The ethical dilemma in the situation is that Mary has to decide if she wants to stick with her cash flow forecasts (which are based on extensive data collection and research done by Mary) or to pay heed to the investment officer’s advice that the cash flow estimates should be higher because the synthetic steel product will have a very good growth. Mary knows that the probability of very good growth will not be a reality and hence this is the ethical dilemma that she is facing. By complying with the wish of the investment officer she will be considered as a team player and her chances of quickly rising the corporate ladder will increase. On the other hand by complying with the wish of the investment officer she will be presenting cash flow numbers that will be misleading and far from reality.

No, it was not appropriate for the investment officer to request Mary to change her cash flow estimates. This is because Mary has developed her cash flows after collecting data from different resources, talking to various departments within the company and after incorporating analyst’s estimates as well. Her cash flow estimates are realistic and by asking Mary to change her cash flow estimates the investment officer is trying to ensure that cash flows shown in the report are higher than the expected and realistic numbers and hence this is wrong and unethical.

No, it was not appropriate for Mary to change her cash flow estimates. Mary, as an accounting and finance professional, has certain professional code of conduct like honesty, integrity, being ethical etc. By changing her forecasts she is providing numbers that are far away from reality and that will, in all likelihood, will not be achieved.

If I were Mary I would have refused to accept the request of investment officer. On being pressed further I would have raised the issue with senior management of the company (like the CEO). I would take this action to ensure that future of the company is not jeopardized based on investments done by it on the basis of inaccurate capital budgeting numbers.