Capital Budgeting 103

Indian companies use a variety of methods to encourage idea generation. The most
common methods used are: (a) management sponsored studies for project identification,
(b) formal suggestion schemes, and (c) consulting advice. Most companies use a
combination of methods. The offer of financial incentives for generating investment
idea is not a popular practice. Other efforts employed by companies in searching
investment ideas are: (a) review of researches done in the country or abroad,
(b) conducting market surveys, and (c) deputing executives to international trade fairs
for identifying new producs/technology.

Once the investment proposals have been identified, they could be submitted for
scrutiny any time. However, some companies do specify a submission time.

Developing Cash Flow Estimation

Estimation of cash flows is a difficult task because the future is uncertain. Operating
managers with the help of finance executives should develop cash now estimates. The
risk associated with cash nows should also be property handled and should be taken
into account in the decision process. Estimation of cash nows requires collection and
analysis of all qualitative and quantitative data, both financial and non-financial in
nature. Large companies would have a management information system providing
such data.

Executives in practice do not always have clarity about estimating cash flows. A large
number of companies do not include additional working capital while estimating the
investment project cash flows. A number of companies also mix up financial flows with
operating flows. Although the companies claim to estimate cash flows on incremental
basis, some of them make no adjustment for sale proceeds of existing assets while
computing the project's initial cost.

Most Indian companies choose an arbitrary period of 5 or 10 years for forecasting cash
flows. This was because companies in India largely depended on govermment-owned
financial institutions for financing their projects, and these institutions required 5 to 10
years forecasts of the project Cash flows.

Evaluation

The evaluation of projects should be performed by a group of experts who have no are
to grind. Far example, the production people may be generally interested in having the
most modem type of equipments and increased production even if productivity is
expected to be low and goods cannot be sold. This attitude can bias their estimates of
cash nows of the proposed projects. Similarly, marketing executives may be too
optimistic about the sales prospects of goods manufactured, and overestimate the
benefits of a proposed new product. It is therefore, necessary to ensure that an
impartial group scrutinizes projects and that objectivity is maintained in the evaluation
process.