An Actual Capital Budgeting Request
Requests to purchase new fixed assets begin with an authorization form like the one below.
The request shown below was used to purchase 17 of the world's largest dump trucks and was used by a mining company in the western U.S. (Some data has been changed to protect the identity of the company.) The summary consists of only three pages:
The first page is essentially a summary of the cost and benefits.
The second page contains details about the individual cash flows.
The third page shows details about the nature of the cost (top of the page) and a summary of the analysis that shows the profitability of the project after comparing the benefits to the cost (bottom of the page).
In this case, the company purchased the 17 dump trucks: the Net Present Value was almost $3 million and the Internal Rate of Return was over 32% per year. The outcome wasn't what the company hoped for however. The company had estimated that the purchase would generate after-tax savings of $2.62 million during the first year and $1.75 during the second year. However, the country of Chile flooded the market with copper and other metals that the company was mining, driving the selling price below the company's production cost. The company shut down the mining operations because it could not longer mine the metals without losing money.
In light of this, was the decision to buy the trucks the wrong decision? No, given the information at the time, it was the right decision - it just didn't achieve the desired outcome. It's an excellent example of how the most carefully constructed cash flow estimates can go awry since we can't predict future events very well. In other words, any time that a financial manager attempts to forecast the future, there will be considerable risk in the cash flow estimates. To see how we can measure and adjust for these risks, visit this page on risk adjustments in capital budgeting.