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Capital Budgeting Three-Part Process

Capital budgeting is a three-part process: data gathering, data analysis, and decisions. The techniques, such as NPV and IRR, are an aspect of data analysis.

The mathematical analysis is not the real challenge since you can use always a financial calculator or financial software application. The hard part is gathering data that is accurate and complete. This involves cash flow estimates, which are usually more fiction than fact.

Question:
Since the analysis relies on the quality of data, what kind of strategies would you recommend to increase the quality of data used for the capital budgeting?

Please include references.

Solution Preview

CASH FLOWS AND CAPITAL BUDGETING

Capital budgeting decisions really depend much on estimated cash flows relevant to a project. However, unless the estimates are realistic, a financial analyst may not come up with correct capital budgeting decisions. The following are some suggestions that may help in ensuring quality of data:
1. Triangulation. This is a concept in research in ensuring that adequate and valid data are obtained. This method requires that data should not only come from one source - it must come from varied sources and as much as possible, three sources. As applied to capital budgeting, the estimates may be obtained from several experts on a particular capital budgeting concern/issue (the financial analyst himself, the marketing manager, and another technical person). Their estimates may be levelled out or averaged. This would ...

Solution Summary

The solution discusses capital budgeting three-part process.

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