Friday, November 12, 2010


Qualitative Factors and Judgment in Capital Budgeting

In theory, the use of sophisticated techniques is emphasized since they maximize value to shareholders. In practice, however, companies, although tending to shift to the formal methods of evaluation, give considerable importance to qualitative factors. Most companies in Asia guided one time or other, by three qualitative factors:
  1. Urgency
  2. Strategy
  3. Environment

All companies think that urgency is the most important consideration while a large number thinks that strategy plays a significant role. Some companies also consider intuition, security and social considerations as important qualitative factors. Companies in USA consider qualitative factors like employees’ morals and safety, investor and customer image, or legal matters important in investment analysis.

Due to the significance of qualitative factors, judgment seems to play an important role. Some typical responses of companies about the role of judgment are:

  • Vision of judgment of the future plays an important role. Factors like market potential, possibility of technology change, trend of government policies, which are judgmental, play importance role.
  • The opportunities and constraints of selecting a project, its evaluation of qualitative and quantitative factors, and the weight age on every bit of pros and cons, cost-benefit analysis, are essential elements of judgment. Thus, it is inevitable for any management decision.
  • Judgment and intuition should definitely be used when a decision of choice has to be made between two or more, closely beneficial projects, or when it involves changing the long-term strategy of the company.
  • It plays a very important role in determining the reliability of figures with the help of quantitative methods as well as other known financial matters affecting the projects.

We feel that what businessman call intuition or simply judgment is in fact informed judgment based on experience. A firm growing in a favorable economic environment will be able to identify profitable opportunities without making net present value or internal rate return computation. Businessmen often act more intelligently than they talk.

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