Question

• There have been times that business executives use the capital budgeting process in unethical ways. Discuss the capital budgeting process used by personnel managers, research and development staffs and advertising executives. Which of these would most likely be dishonest and unethical in preparing capital budgets?
• Requirements: 250 words

Answer 1

Capital budgeting helps an organisation to understand the risk factors involved in any investment and the way these risk factors affect the final returns.

The steps involved in the process are as follows:

Step 1: We need to determine the total amount of the investment which may include the total cost of the asset being acquired investment required to fund the project. In case of advertising executives, it may be the cost of producing commercial whereas it may be the cost of chemicals/equipment etc. required to carry out the research and development in case of R&D staff.

Step 2: We need to determine the cash flows returned by investment by projecting income statement for eg. the projected sales from launching a new medicine or increase in sales from launching the commercial on media.

Step 3: We need to determine the terminal value which is basically the net sales proceeds obtained from selling of the asset after its useful life.

Step 4: We need to calculate the NPV of the cash flows of the investment and match them with the respective periods in which they occur The NPV is the sum of the PV of each year’s cash flow. To calculate the PV of each year’s cash flow, the following formula is used:

PV = Cash Flow ÷ (1 + r)^ Year (Here r is the discount rate)

Step 5: Lastly, we need to run a sensitivity analysis and stress test by building multiple scenarios (best case, normal , worst case etc.)

Out of the three categories mentioned, Advertising executives have targets based incentives and hence are most likely to be dishonest and unethical in preparing capital budgets.