Determining the ranking of mutually exclusive projects is another step used by firms in the decision making process. Investments are determined on an annual basis by a business's board in agreement with and limited by the company's spending budget for the year. Once the capital budgeting and sensitivity analysis reports are complete on all projects, the projects are then reviewed on additional factors such as overall purpose within the company, and are ranked from best to worst (Bacon, 1977). Those projects that fail to meet certain numerical hurdles are simply eliminated from the list and not considered by an investment board. Some decisions may be close to certain numerical hurdles but also have other overarching reasons for acceptance. Some examples may include investments for improvements in compliance with legislation. These investments must be done regardless of their overall worth, and typically are more beneficial to a company if done sooner rather than later. Another factor that is often considered during this phase of decision making is the role of duration (Barney, 2004). Ideally an investment's initial cost is paid off within a minimal amount of time and can be reinvested into new projects. Should a project take too long, it will not be considered viable.
A final crucial factor that businesses consider is inflation. While inflation is technically a part of capital budgeting, it is one factor that any business in the international market considers consistently. Every decision, especially debt investments, are tied to the...
When a currency is devalued either through interest rates or external factors, an investment loses value to the company and becomes more expensive overall for payoff (Mills, 1996). To ensure that investments are handled wisely, worst case scenario inflation is always considered.
It is well understood in the business world that no investment should be made without careful consideration of the true cost. While business may take risks, every risk is calculated to the finest minutia and outcomes are predicted to prevent unforeseen failure. When properly adopted and evaluated, even failed risks are considered prudent so long as the economic reports reflected good decision making at the time.
References
Bacon, Peter (1977). The Evaluation of Mutually Exclusive Investments. Financial Management. Vol 6.2, 55-58.
Barney, Dwayne; Danielson, Morris (2004). Ranking Mutally Exclusive Projects: The Role of Duration. The Engineering Economist. Vol 49.1, 43-61.
Mills, Geofrey (1996). The Impact of Inflation on Capital Budgeting and Working Capital. Journal of Financial and Strategic Decisions. Vol 9.1, 79-87.
Pannell, D.J. (1997). Sensitivity analysis of normative economic models: Theoretical framework and practical strategies. Agricultural Economics. 16, 139-152.
Saltelli, a; et al. (2005). Sensitivity Analysis for Chemical Models. Chemical Reviews. Vol. 105.7, 2811-2828.
Sullivan, Arthur; Steven M. Sheffrin (2003). Economics: Principles in Action. Upper…
