As capital budgeting essentially re-invents the company through major long-term
ID: 2794356 • Letter: A
Question
As capital budgeting essentially re-invents the company through major long-term expenditures it is arguably one of the most critical functions that financial management performs. However, based on my personal experiences, extensive empirical data, and antidotal data - many firms routinely experience significant failures in their selection of capital projects.
1) For your first topic in this conference I would like for you to briefly review either your personal experiences and/or the financial literature to identify and present a description of one actual capital project/product failure and the reasons attributed to the failure. For those of you who do not have personal experiences the following are some illustrated examples of failed projects/products over the last 50 years you may want to look up and consider: -New Coke,- The Iridium Satellite Communication,- the Edsel automobile, Beta (vs. VHS), the Concord SST, and various Dot Coms. Feel free to research others. In your response please provide financial information regarding the project (what is available): initial outlay, projected cash flows, final dollar losses. This is one to two paragraph exercise - - . I am interested only in your short, concise description and the major reasons you believe it failed.
2) Synthesize your one-paragraph position on what 3-5 specific factors you believe most likely to contribute to capital project analysis failure.
Explanation / Answer
Capital Projects are usually long gestation projects which have to be carefully evaluated for their feasibility before going in for their execution or implementation. Some of these projects involve huge outlay of capital which can really burden your existing business finances. So, it is important to estimate the future cash flows that the capital project will generate and what will be the hurdle rate that will be applied for evaluating the project? Is the planned project carrying the same business risk as that of the existing business? This is important in deciding the hurdle rate for the project. Has the proper risk analysis been conducted for the project during execution stage and initital years of its operation? The sources of funds for the project has to be identified, will the project be funded by debt or will new equity be issues. Will there be any impact on the existing capital structure of the firm?
What happens if the project has to be closed due to unforeseen reasons? And what could be the possible reasons of failure - banks stopped funding to the project in between leading to credit crunch for the project, vendors defaulted in supplying the material on time, or the execution risk because of some natural hazard in the region and the project went completely out of track. The design of the project has to be vetted and thoroughly studied before commencing the execution. Some of these reasons are the prime reasons that the projects fail. Organizations which touch and carefully analyze each point before project execution rarely falls in the trap late and will most likely lead to successful project completion.
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