The Shaky Foundations of Capital Budgeting

by Bela Gold



Major investments in industry, whether involving technological innovations, capacity expansion, or other purposes obviously constitute one of the most critical areas of managerial decision-making and thus have been a primary target of efforts to develop increasingly sophisticated guides to evaluating relevant alternatives. The most fundamental of all premises underlying quantitative capital budgeting techniques is that it is possible to forecast the time patterns of investment and operating expenditures as well as of revenues and net incomes over the entire life of contemplated projects. Although a considerable literature concerning capital budgeting has developed, surprisingly little attention has been given to identifying the considerable structure of forecasts underlying the aggregative estimates entering into capital budgeting calculations. Forecasts of the investment required to construct planned facilities involve supplementing the initial estimates derived from engineering designs and plans with the additional estimates of prospective changes in factor prices during the construction period, possible delays in the construction schedule, unexpected difficulties in getting new facilities to function properly, especially in the case of innovation and emerging needs for readjustments in associated sectors of operation to achieve effective integration.

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