A consultant commented that \"too often the numbers look good but feel bad.\" Th

Question

A consultant commented that "too often the numbers look good but feel bad." This comment often stems from estimation error common to capital budgeting proposals that relate to future cash flows. There are several reasons management and consultants may feel this way. Research using the BC Library databases this topic, discuss some of those reasons (findings), and provide an example to support your post. Follow the minimum requirements for discussion board posts located in the general discussion area. Recall, those are the minimum requirements, more posts are always encouraged.

Explanation / Answer

Risk analysis is the process of evaluating the nature and scope of expected and unexpected setbacks that may derail the achievement of investment goals. A capital budgeting risk is the likelihood of a long-term investment failing to generate the expected cash flows. Such risks arise from imperfections in future cash flow estimates, a situation that exposes your business to possibilities of embracing loss-making capital investments. Always analyze such probable risks and apply the appropriate risk premiums -- that is, the applicable rate of returns you should earn for embracing the extra risks.

First, it is very difficult to reliably predict cash flow several years into the future. Second, the present value of cash flows many years into the future (say beyond 10 years) is often very small.

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