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Caterpillar Capital Budgeting
Qualitative Factors
There are a number of qualitative factor that go into a capital budgeting decision. The first is that the company needs to think about how the purchase fits with its overall strategy. Caterpillar has an overall strategy, and its resources should be directed towards that. It has to think if a new computer network system -- which will have more costs than just 10% of last year's profits because there is a learning curve with new computer systems -- is going to be a good use of resources. Opportunity costs are a major issue in capital budgeting decisions because that money could be deployed elsewhere (CFA Institute, 2014).
There are other qualitative factors as well. For example, activities must be within the ethical framework of the company. They must also have a positive effect on some element of the company's objectives, like customer service. Ideally, Caterpillar will be able to quantify this impact, but prior to the decision the positive impact on customers is theoretical only, so exists mostly in a qualitative state. There are also environmental considerations (Ingram, 2014). The new computer system does appear to work within all of these, so can...
Another factor is sustainability of the benefits. New software may be powerful, but competitors can buy the same software, or design their own. The life cycle of software is not that long. This project will have to pay for itself quickly.
For Caterpillar, it is assumed that it will look at the qualitative factors, and in this case there is no reason to believe that the new computer system would not be approved. It has not been stated in the three sentence situational description whether or not there are any opportunity costs, so it will be assumed that there are none. If there were, Caterpillar would have a lot more to think about.
To make the decision, Caterpillar would first identify a set of priorities. First, the money, the quantitative analysis, is going to be critical. The project needs to have a positive net present value in order to gain approval. The company's goals are related to increasing shareholder wealth, so anything that accomplishes that goal will at least be given consideration. Then, the second-most important criterion is the opportunity costs related to the project. The cost of the project, based on last year's profits, is $378 million (MSN…
References
CFA Institute. (2014). Capital budgeting. CFA Institute. Retrieved November 13, 2014 from http://www.cfainstitute.org/learning/products/publications/inv/Documents/corporate_finance_chapter2.pptx
Ingram, D. (2014). Qualitative factors in capital investment decisions. Houston Chronicle. Retrieved November 13, 2014 from http://smallbusiness.chron.com/qualitative-factors-capital-investment-decisions-73769.html
MSN Moneycentral. (2014). Caterpillar, Inc. Retrieved November 13, 2014 from http://www.msn.com/en-us/money/stockdetails/financials/fi-CAT?ocid=qbeb
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