1. After reading the "Ethical Issues" box on page 330 of the required text, devise a plan that will minimize or reduce the impact of these cash flow estimation biases on effective decision-making. 2. The CFO of a firm you just started working for claims "we always have, and always will, use the weighted average cost of capital (WACC) as the rate to discount future expected cash flows frorm our proposed capital budgeting projects" What do you think of this strategy? ETHICAL ISSUES Cash Flow Estimation Biases The estimation of the cash flows associated with an investment project is the most important step in the capital expenditure evaluation process. If the cash flow estimates associated with a project are inten- tionally or unintentionally biased, a firm's resources are unlikely to be allocated to the set of investment projects that will maximize shareholder wealth. Second, some firms tie employee compensation performance relative to stated objective sation scheme often called management by obje If a manager is confident that the best estimate of the cash flows from a proposed project is sufficiently large to guarantee project acceptance, the manager may be tempted to reduce these cash flow estimates There are several reasons why managers might to a level below the "most likely outcome" level, con produce biased cash flow estimates when preparing fident that the project will continue to be viewed as an capital expenditure project proposals. First, a manager acceptable investment and that it will be funded. How might be tempted to overestimate the revenues or ever, once the project is under way, the project man underestimate the costs associated with a project if ager will feel less pressure to meet projected the manager is attempting to expand the resource performance standards. The downward bias in the base over which he or she has control. By biasing the cash flow estimates provides a cushion that permits estimates of a project's cash flows upward, a manager suboptimal management of the project while achiev s likely to receive a larger share of the investment ing the objectives enunciated when the project was resources of the firm. Because managerial compensa- first proposed. tion is sometimes tied to the span of job responsibili- ies, managers may be tempted to expand this span of estimates for investment projects hav control at the expense of other areas in the firm What impact does intentionally biasing cash flow e on achievin the goal of shareholder wealth maximization? 1. After reading the "Ethical Issues" box on page 330 of the required text, devise a plan that will minimize or reduce the impact of these cash flow estimation biases on effective decision-making. 2. The CFO of a firm you just started working for claims "we always have, and always will, use the weighted average cost of capital (WACC) as the rate to discount future expected cash flows frorm our proposed capital budgeting projects" What do you think of this strategy? ETHICAL ISSUES Cash Flow Estimation Biases The estimation of the cash flows associated with an investment project is the most important step in the capital expenditure evaluation process. If the cash flow estimates associated with a project are inten- tionally or unintentionally biased, a firm's resources are unlikely to be allocated to the set of investment projects that will maximize shareholder wealth. Second, some firms tie employee compensation performance relative to stated objective sation scheme often called management by obje If a manager is confident that the best estimate of the cash flows from a proposed project is sufficiently large to guarantee project acceptance, the manager may be tempted to reduce these cash flow estimates There are several reasons why managers might to a level below the "most likely outcome" level, con produce biased cash flow estimates when preparing fident that the project will continue to be viewed as an capital expenditure project proposals. First, a manager acceptable investment and that it will be funded. How might be tempted to overestimate the revenues or ever, once the project is under way, the project man underestimate the costs associated with a project if ager will feel less pressure to meet projected the manager is attempting to expand the resource performance standards. The downward bias in the base over which he or she has control. By biasing the cash flow estimates provides a cushion that permits estimates of a project's cash flows upward, a manager suboptimal management of the project while achiev s likely to receive a larger share of the investment ing the objectives enunciated when the project was resources of the firm. Because managerial compensa- first proposed. tion is sometimes tied to the span of job responsibili- ies, managers may be tempted to expand this span of estimates for investment projects hav control at the expense of other areas in the firm What impact does intentionally biasing cash flow e on achievin the goal of shareholder wealth maximization