Which is better for your firm? Invest prodigious amounts of capital or scale back on capital investment? Reduce employment to raise the dollar amount of assets at work per employee or elevate employment to meet the demands created by new investments? Questions like these confront all senior managers as they formulate strategic plans and allocate capital. The questions become more compelling as investors demand that corporations consistently deliver shareholder value regardless of their long-term strategy for deploying human and financial capital.
An important factor that distinguishes the winners from the losers in creating shareholder value is the quality of investment decisions, which, in turn, depends on the soundness of a firm’s capital budgeting system. Unfortunately, the history of corporate America is littered with examples of poor investment decisions, ranging from investing too little in positive NPV (net present value) projects and too much in negative NPV projects to investment myopia.1 Such distortions can distract companies from what they do best, causing them to sink millions of dollars in the wrong products and ideas. For instance, Coca-Cola invested in pastas and wines, products for which its rates of return were not only well below those of its core soft-drinks business, but also below its cost of capital. Such errors deplete shareholder value and lead to... To read the complete article, login or sign-up using the form below.
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