We have so far looked at ways to identify relevant cash flows and techniques for analyzing them. The final stage (Stage 5) of capital budgeting begins with implementing the decision and managing the project.* This includes management control of the investment activity itself, as well as the project as a whole.
Capital budgeting projects, such as purchasing a hybrid bus or videoconferencing equipment, are easier to implement than projects involving building shopping malls or manufacturing plants. The building projects are more complex, so monitoring and controlling the investment schedules and budgets are critical to successfully completing the investment activity. This leads to the second dimension of Stage 5 in the capital budgeting process: evaluate performance and learn.
A post-investment audit provides managers with feedback about the performance of a project so they can compare the actual results to the costs and benefits expected at the time the project was selected. Suppose the actual outcomes (such as the additional operating cash flows from Vector’s purchase of a new hybrid bus) are much lower than expected. Managers must then determine if this result occurred because the original estimates were overly optimistic or because of implementation problems. Either of these explanations is a concern.
Optimistic estimates can result in managers accepting a project they should have rejected. To discourage unrealistic forecasts, companies such as DuPont maintain records comparing the actual results of the firm’s projects to the estimates individual managers either made or signed off on when seeking approval for capital investments. Post-investment audits prevent managers from overstating the expected cash inflows from projects and accepting projects they should reject. Implementation problems, such as weak project management, poor quality control, or inadequate marketing, are also a concern. Post-investment audits help to alert senior management to these problems so they can be quickly corrected.
Companies should perform post-investment audits with thought and care, and only after the outcomes of projects are fully known. Performing audits too early can be misleading. In addition, obtaining actual results to compare against estimates is often difficult. For example, in any particular period, macroeconomic factors, such as the weather and changes in fuel prices, can greatly affect the ridership on buses and the costs of running them. Consequently, the overall additional net revenues from Vector’s new hybrid bus may not be immediately comparable to the estimated revenues. A better evaluation would look at the average revenues across a couple of seasons.