Appropriation Phase Of Capital Budgeting

The focus of the appropriation phase, sometimes called the development or selection phase, is to appraise the projects uncovered during the identification phase. After examining numerous firm and economic factors, the firm will develop estimates of expected cash flows for each project under examination. Once cash flows have been estimated, the firm can apply time value of money techniques to determine which projects will increase shareholder wealth the most. The appropriation phase begins with information generation, which is probably the most difficult and costly part of the phase. Information generation develops three types of data: internal financial data, external economic and political data, and nonfinancial data. This data supports forecasts of firm-specific financial data, which are then used to estimate a projectís cash flows. Depending upon the size and scope of the project, a variety of data items may need to be gathered in the information generation stage. Many economic influences can directly impact the success of a project by affecting sales revenues, costs, exchange rates, and overall project cash flows. Regulatory trends and political environment factors, both in the domestic and foreign economies, also may help or hinder the success of proposed projects. Financial data relevant to the project is developed from sources such as marketing research, production analysis, and economic analysis. Using the firmís research resources and internal data, analysts estimate the cost of the investment, working capital needs, projected cash flows, and financing costs. If public information is available on competitorsí lines of business, this also needs to be incorporated into the analysis to help estimate potential cash flows and to determine the effects of the project on the competition. Nonfinancial information relevant to the cash flow estimation process includes data on the various means that may be used to distribute products to consumers, the quality and quantity of the domestic or nondomestic labor forces, the dynamics of technological change in the targeted market, and information from a strategic analysis of competitors. Analysts should assess the strengths and weaknesses of competitors and how they will react if the firm undertakes its own project. After identifying potentially wealth-enhancing projects, a written proposal, sometimes called a request for appropriation is developed and submitted to the manager with the authority to approve. In general, a typical request for appropriation requires an executive summary of the proposal, a detailed analysis of the project, and data to support the analysis. The meat of the appropriation request lies in the detailed analysis. It usually includes sections dealing with the need for the project, the problem or opportunity that the project addresses, how the project fits with top managementís stated objectives and goals for the firm, and any impact the project may have on other operations of the firm. The appropriation process concludes with a decision. Based upon the analysis, top management decides which projects appear most likely to enhance shareholder wealth. The decision criterion should incorporate the firmís primary goal of maximizing shareholder wealth.