Capital budgeting and Non-financial Issues
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1. Capital budgeting decisions are not always determined by the numbers. What nonfinancial issues might override the results of a discounted cash flows analysis (and cause a project to be accepted even though its return is below the company's normal required return)?
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Solution Summary
This solution discusses how the numbers do not always determine capital budgeting decisions, and specifically explains nonfinancial issues that might override the results of a discounted cash flows analysis.
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1. Capital budgeting decisions are not always determined by the numbers. What nonfinancial issues might override the results of a discounted cash flows analysis (and cause a project to be accepted even though its return is below the company's normal required return)?
Corporate capital budgeting systems often use acceptance criteria for capital investments that depend on the objective of the project. Non-quantitative (i.e., nonfinancial criteria) are sometimes accepted as a justification for projects involving considerations such as:
1. Safety,
2. Convenience,
3. Product quality,
However, projects designed to increase profits are usually subjected to strict quantitative guidelines on the payback period and internal rate of return computed from projected after-tax cash flows. Saying that, though, nonfinancial issues such as safety, convenience or product quality may override the results of a discounted cash flows analysis and cause a project to be accepted even though its return is below the company's normal required return (see http://64.233.179.104/search?q=cache:jdWRwP_rUbYJ:www.exinfm.com/training/6301l6.rtf+project+accepted+company%27s+normal+required+return&hl=en).
Example 1
Some companies use both financial and non-financial issues to determine capital budgeting decisions. For example, the ultimate goal is to tie forecasts more closely to Texaco's strategic and tactical plans. Because the business ...
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