Any capital budgeting decision should depend solely on a project's forecasted cash flows and the firm's...

Any capital budgeting decision should depend solely on a project's forecasted cash flows and the firm's opportunity rate of return. Such a decision should not be affected by managers' tastes, the choice of accounting method, or the profitability of other independent projects

Expert Solution

Answer: Yes. Statement is completely correct. Capital budgeting solely should be decided on the cash flows and rate of return and should be looked objectively

It you look at all the methods used in Capital budgeting from NPV, IRR to payback period, they use objective data points only to tell whether you should go for the project or not.

If projects are chosen based on managers tastes it will impact the fair decision making and the concept of agency costs in a business would very well come in to picture where manager will make decisions which suits them the most not the Company.

Using accounting method is not real gain its just in the balance sheets only of the Company.

If any other project is giving good returns in a scenario where the company has money to invest in only one project then it will make sense to invest in higher rate of return project only.so profitability of other independent projects will effect the choice only in case of money scarcity for investment.

jeff jeffy answered 1 year ago

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