Capital Budgeting the Underlying Principles Thesis

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When a range of options are presented to management, the capital budgeting process must be used to determine the costs and cash flows associated with each option. However, the capital budgeting process is only as valuable as the inputs and assumptions. If the assumptions are not grounded in reasonable analysis and quality research, the process will not yield a valuable result. If the numbers that are input into the capital budgeting model are dubious, the decision will also be dubious. Sensitivity analysis can help to mitigate some of the risks associated with the assumptions that go into any capital budgeting decision, but even they cannot guard against sloppy work. The capital budgeting process is ultimately one that must be given utmost attention to detail.

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This is not despite the fact that it is based on predictions of future events but because of that fact. The better the knowledge of present conditions and past trends, the better the estimation of future cash flows will be. The better the estimation of future cash flows, the stronger will be the capital budgeting process.

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